Xero Limited 2020 Annual
Report For personal use only use personal For For personal use only use personal For
Cover images:
Momentum Accounting, United States Orenda Tribe, United States Moovaz, Singapore Contents
2–3 4–6 7–12 Highlights Chair’s Review CEO’s Review
13–14 15–30 32–35 The Board Management Auditor’s of Directors Commentary Report
36–39 40–70 71–86 Financial Notes to the Corporate Statements Financial Governance Statements Statement
87–93 94–111 112 Disclosures Remuneration Corporate
For personal use only use personal For Report Directory Highlights
OPERATING REVENUE FREE CASH FLOW $718.2 m $27.1 m Up 30% YOY Up $20.7m YOY
NET PROFIT SUBSCRIBERS $3.3 m 2.285m Increase of $30.5 million YOY Up 467,000 YOY
TOTAL AVAILABLE LIQUIDITY ANNUALISED MONTHLY RECURRING REVENUE $686.1 m Cash on hand, short-term deposits including $820.6 m proceeds from convertible notes, and undrawn Up 29% YOY committed debt facilities
TOTAL SUBSCRIBER LIFETIME VALUE GROSS MARGIN PERCENTAGE $5.5 b 85.2 %
Up $1.2 billion YOY Up 1.6 percentage points For personal use only use personal For HIGHLIGHTS 3
A global Offset 100% ecosystem of of our carbon 800+ apps, emissions 200+ connections for FY19 and to financial services committed to providers remaining ‘net zero’ going forward
SCALE OF THE PLATFORM Total value of transactions through Xero platform in FY20 at 31 March 2020 42% of Xero’s $3.62 t* employees
Total value of invoices raised were female via Xero during FY20 Xero was one of 325 b global companies $853.2 included in the 2020 Bloomberg Gender-
Equality Index For personal use only use personal For
*Incoming and outgoing transactions, 12-month period 4
Chair’s Review
Dear shareholder Xero is a unique company - a digital disruptor, born in the Southern Hemisphere - that operates at the intersection of technology and finance, with the opportunity to serve the entire global small business economy.
This past year as a director, I have come to fully many small businesses are facing financial hardship understand the vital role Xero plays in supporting and we have ensured, as has always been the case, small businesses, their advisors and communities that customers in distress are able to downgrade or around the world. Xero is becoming an integral part of suspend their subscriptions through this difficult time. the small business community and economies around The Xero leadership team has responded strongly the globe. to support our people, partners and small As COVID-19 impacts businesses and communities, business customers during the COVID-19 crisis. Xero is focused on supporting our customers and Our global teams are committed to upholding the
maintaining the quality and continuity of our cloud- entrepreneurial spirit of Xero’s start-up heritage, while For personal use only use personal For based products and services. Unquestionably, this is a building the capabilities and processes to support difficult time for many of our customers. a global technology company, and focusing on additional ways to support our customers. We have moved swiftly to develop and roll out a range of new support services for small business as well as for accountants and bookkeepers. We recognise XERO LIMITED 5
FY20 overview Risk management & security We are pleased to announce for the year ended Risk management has always been critical in our 31 March 2020 (FY20), Xero was able to maintain ability to execute our strategic and operational financial and operating performance momentum. priorities, but is even more important in challenging Xero delivered top-line growth, a first ever full-year times like this. From a governance perspective, the net profit after tax, and a positive free cash flow Board is closely monitoring Xero’s risk management result. This is testimony to the importance of the activities in light of COVID-19. Xero platform to the operations of our customers Security and data protection are central to our and partners. vision of being a trusted and insightful platform. We continue to invest and deliver improvements Xero is becoming an integral part of across data governance, security, scalability, and our the small business community and quality of service. We are committed to protecting economies around the globe our customers' information, educating the Xero community about best practice in online security, and ensuring guardrails are in place to safeguard data However, the impact of COVID-19 on March trading that flows through our platform. did result in some reduction in annualised monthly recurring revenue (AMRR) progress in that month. Board update This outcome, along with the ongoing COVID-19 On behalf of the Board and everyone at Xero we environment, will be reflected in Xero’s FY21 extend our sincere thanks to Graham Smith, our financial performance. Xero does not anticipate former Chair. Graham stepped down as Chair on 31 significant changes to its long-term strategy and we January and retired from the Board at the end of believe strongly in the value Xero can bring to small the financial year after supporting a smooth businesses and their advisors. Chair succession.
We remain focused on building our community and During the financial year, we also farewelled Bill introducing small businesses to the benefits of Veghte from the Board after five years, and we thank doing business in the cloud and, for those already Bill for his dedicated service. using Xero, extending their activities beyond We welcomed Mark Cross to the Board as an cloud accounting. independent non-executive director on 1 April. Capital management Among his many strengths, Mark brings to Xero Xero had total available liquid resources of $686 considerable experience and expertise in corporate million at 31 March 2020. The US$300 million raised finance and financial markets. from the convertible notes issue in October 2018 Xero has an engaged and experienced Board of remains largely available to fund future investment Directors who are closely connected to the business. opportunities. Our standby $150 million debt facility It has been a pleasure to join this team, and I’d remains undrawn and is available for short-term like to acknowledge my fellow directors for their liquidity requirements should it be required. commitment and thoughtful counsel during the year. Our capital allocation framework remains focused Diversity & Inclusion on enabling the business to grow, both through We believe that healthy teams are diverse and organic opportunities and, where appropriate, inclusive. While there is always more to do, we through the pursuit of complementary targeted
For personal use only use personal For are proud that female representation on Xero’s acquisitions that we believe support the execution leadership team and across all our employees sits at of our strategic priorities. 42 percent. The Board set a measurable objective for FY20 to maintain a gender balance with at least three female directors and three male directors, which we have achieved and retain as an objective in FY21. 6 CHAIR’S REVIEW
In FY20, we set and achieved numerical targets around representation of women on Xero’s leadership team and across our employees. These are expressed as a 40:40:20 approach – at least 40 percent women and 40 percent men, with the remaining 20 percent unspecified, to allow for flexibility and recognising that gender is not binary.
We have also continued our efforts to ensure Xero is an inclusive work environment including initiatives such as LGBTQI+ inclusion, disability inclusion, cultural diversity, flexible working, and employee wellbeing.
More information about our initiatives to support progress in this area is set out in the corporate governance statement (see page 71).
Conclusion This year Xero has drawn together remuneration information in a consolidated remuneration report (see page 94). We will continue to evolve this report and we welcome your feedback.
On behalf of the Board, I would like to thank our talented and passionate team of Xero people for their valuable contributions in FY20. Finally, I'd like to sincerely thank our customers, partners, and investors for your ongoing trust and confidence in Xero.
David Thodey
Xero Chair For personal use only use personal For XERO LIMITED 7
CEO’s Review
Dear shareholder There’s no doubt we are facing a time like no other as COVID-19 impacts each of us, so I start by sending you our best wishes. We hope that you and those you care about are safe and well.
It is clear that businesses and communities are Supporting our customers and partners during now under pressure in what is both a global COVID-19 health and economic crisis. Many of Xero’s small We have moved quickly to support our small business business customers, bookkeepers, accountants, and customers and accounting and bookkeeping partners ecosystem partners are having to adapt the way during COVID-19 through a range of new initiatives they operate and invest enormous emotional and focused on providing immediate information and operational effort to find pathways for support including: business survival. • A business continuity hub on Xero Central, our Businesses are being forced to reset priorities, and main customer support centre, which offers a Xero is no different. Although our long-term strategy range of resources, including business continuity remains unchanged, we’ve made clear decisions on planning, cash flow management and working from what we can delay or do without for now, and what home effectively
For personal use only use personal For must be protected. In that process, three overarching • A dedicated 24/7 customer response team to, priorities emerge: the need for us to support our among other things, help customers understand customers and partners, the welfare of Xero’s people, and access government funding programs available and the need to ensure continuity of the platform that to them supports the operations of our millions of subscribers and their advisors. 8 CEO’S REVIEW
• We have prioritised product development in key Sydney. We communicated our decision early to COVID-19 response areas including short-term cash minimise disruption and impact on our partners, flow and business snapshot features, in-product sponsors, speakers, event staff, and employees. We prompts and reminders to help stay informed of are now considering alternative digital events to government stimulus packages connect with our community of cloud accounting leaders to share our latest product and • Simplifying and automating payroll and tax technology updates. changes to help small businesses with reporting and filing of data, to prove eligibility and access I am incredibly proud of the way our people have government stimulus benefits and with financial embraced the challenges and changes we’ve faced institutions where applicable during these past months. It is a real credit to them and the culture of Xero that we have been able • We also deferred a planned price rise, and from to live our values, and support one another and 1 April improved Xero's global small business our customers. supplier payment terms to paying in 10 days FY20 results update Xero finished FY20 with 2.3 million subscribers During COVID-19 we have moved globally and delivered top-line growth and a positive quickly to support our small business free cash flow result that mean the business has a customers and accounting and sound financial position heading into FY21. bookkeeping partners through a range of new initiatives focused on Digitisation of tax and compliance remained a providing immediate information key driver of demand for Xero’s cloud accounting and support solutions. The positive subscription growth achieved was supported by Xero’s product and marketing response to a number of regulatory initiatives. People as a priority These included the ATO’s Single Touch Payroll (STP) Our people have adapted well to working from home initiative in Australia, and HM Revenue & Customs’ under COVID-19, although this has brought personal (HMRC) Making Tax Digital (MTD) for VAT initiative and work challenges particularly for those with in the UK. younger children, living alone, or with homes not easily adapted to work environments.
Our teams are well connected and work collaboratively by using cloud-based tools and Performance highlights FY20 technology, which are embedded in the way we (All figures in NZD as at 31 March 2020. operate our global business and allow us to work in an Comparisons are made against FY19) agile way to solve customer and business problems. • 30% growth in operating revenue to $718.2 Our ability to respond to COVID-19 has been million (29% in constant currency (CC)) supported by a number of actions we took before the • 29% growth in AMRR to $820.6 million onset of the global crisis. These included bringing together our global Customer Experience, Marketing, • 26% growth in total subscribers to 2.285 Education, Sales, and Communications teams into million a single portfolio under our Chief Customer Officer. • Rest of World and North America For personal use only use personal For This focus on customers helps to ensure consistency contributed almost one in four subscriber of decision making and sharing of insights and ideas additions in H2 FY20 around the needs of our customers in all markets. • Total subscriber lifetime value grew by 27% Due to COVID-19, we have cancelled our Asia-Pacific (25% in CC) to $5.5 billion Xerocon event scheduled for September 2020 in XERO LIMITED 9
businesses were acquired in the past two years and • Free cash flow was $27.1 million, taking total successfully embedded into Xero’s product portfolio. available liquid resources to $686.1 million Hubdoc is now included in all Xero business edition • Net profit of $3.3 million, an improvement of plans, helping to deliver on our vision for intelligent $30.5 million over a net loss of $27.1 million automation and code-free accounting. Xero Tax in the UK, built on technology acquired via our Instafile • EBITDA of $137.7 million, an improvement of acquisition, provides accountants and bookkeepers 88% compared to $73.2 million with an easier way to deal with their tax and compliance needs.
In addition, we announced a number of new product Product & Strategy enhancements during the year, including short-term While COVID-19 has required us to rapidly implement cash flow and business snapshot feature pilots for immediate solutions to help our customers, our our customers. long-term strategy and ambitions are unchanged. We remain committed to three strategic priorities: to Xero customers have access to an ecosystem of more drive cloud accounting around the world, grow the than 800 connected apps and over 200 connections small business platform, and build for global scale to financial services providers through our small and innovation. business platform. These connections are with some of the largest banks and fintechs in the world.
Digitisation of tax and compliance We also developed new and tighter workflow-driven remained a key driver of demand for integrations relating to receiving payments and Xero’s cloud accounting solutions. The paying bills. For invoice payments, we announced positive subscription growth achieved global agreements with Stripe and GoCardless and was supported by Xero’s product and a recent partnership with Square in Australia. We marketing response to a number of announced innovative bill payment partnerships regulatory initiatives with TransferWise in the UK and NAB in Australia. The latter was recognised by Canstar (Australasia’s leading product comparison site) with an Innovation Xero’s purpose is to make life better for people in Excellence Award for 2020. small business, their advisors and communities around the world. Our vision is ‘to be the most Outlook insightful and trusted platform for small While Xero has performed strongly in FY20, trading business’. This underpins our strategy and our in the early stages of FY21 has been impacted by the innovation pipeline. COVID-19 environment. The continued uncertainty surrounding COVID-19 means it would be This vision demands that we put data at the centre of speculative for us to say anything more at this time everything we do, to develop new products, smarter on its potential impact on our expected performance services, more personalised customer experiences for FY21. and richer partnerships. Xero’s ambition is to be a long-term oriented, We have invested in strategic capabilities and a high-growth business. We continue to operate with strategy that reflects our aspiration and the size of the disciplined cost management and targeted allocation opportunity we have for the next 10 years and beyond.
of capital. This allows us to remain agile so we can For personal use only use personal For Our product vision is based on a passion to provide continue to innovate, invest, support our customers, smarter, simpler and seamless workflows and trusted and respond to opportunities and changes in our insights to our customers. We delivered important operating environment. product milestones in the year with the bundling of Hubdoc and the integration of Instafile. Both 10 CEO’S REVIEW
Conclusion These are extraordinary times, both in life and in business. As remote working becomes the norm and digitisation of the small business economy and government compliance continues to gather pace around the world, we are focused on making it easier to manage small business by using the power of cloud- based technologies.
COVID-19 presents significant challenges to say the least, and has required all of us to quickly adjust. The Xero executive team and I are committed to supporting and connecting closely with our customers, partners, and our people at Xero during this time.
Thanks to our people, our customers and communities, shareholders, and to everyone who supports Xero.
Steve Vamos
Chief Executive Officer For personal use only use personal For XERO LIMITED 11
Market highlights
FY20 Australia New Zealand United Kingdom North America Rest of World Subscribers 914k +26% 392k +12% 613k +32% 241k +24% 125k +51% Net additions 188k +31% 41k -18% 150k -1% 46k +5%1 42k +68% Revenue $320m +23% $116m +19% $184m +54% $55m +25% $43m +43%
1 Excludes acquired Hubdoc subscribers in FY19
Australia subscribers grew by 26% in the year to North America subscribers grew by 24% in reach 914,000. Net subscriber additions of 188,000 the year to 241,000. Net additions of 26,000 in set a new high for net additions in all our markets. H2 FY20 compared to 17,000 in H2 FY19. This Revenue was up 23% (25% in CC). We continued to is a strong indicator of the early progress from benefit from the opportunity represented by Single our renewed positioning in a key global market. Touch Payroll Revenue grew by 25% (19% in CC)
UK subscribers grew by 32% to 613,000. Revenue Rest of World subscribers grew by 51% to grew by 54% (50% in CC). The strong net 125,000, maintaining the momentum that this part subscriber additions of 150,000 were assisted in of the business has reported in recent periods. part by the Making Tax Digital initiative and by Revenue grew by 43% (36% in CC) Xero Tax now offering end-to-end integration Detailed updates and analysis of Xero’s FY20 with HMRC
For personal use only use personal For financial performance can be found in the New Zealand subscribers grew by 12% in the management commentary on pages 15–30 year to 392,000, with 41,000 subscribers joining in FY20. Revenue outpaced subscriber growth, increasing by 19% 12 CEO’S REVIEW
Social and environmental impact is entitled to a paid day of leave each year to help As a purpose-led business, we understand the not-for-profit organisations in their community. importance of our responsibility as a global citizen Xero launched the Forward Fund scholarship in the and to the communities we serve. Xero’s social and US to give aspiring accounting students assistance environmental impact (SEI) program has been via three USD$10,000 scholarships. a priority during FY20. We have made investments and commitments We announced Net Zero @ Xero, a IRONME to support the environment, NV NT commitment to offset 100 percent sustainability and communities E of our carbon emissions to around the world. & become carbon neutral, TY INC I L while also looking to Raising awareness around S U R S reduce our environmental
the importance of mental B E I V O impact. Subsequently, we
U I health in New Zealand, we N
S OUR announced we had offset extended the pilot of the D
I PEOPLE S 100 percent of Xero’s Xero Assistance Programme N E carbon emissions for the (XAP) to provide free and E I S T year to 31 March 2019 confidential wellbeing I S (assessed retrospectively support to our customers N S U and finalised during and partners, as well as their U P M FY20). To achieve this, Xero employees and families. P M O R C O invested in three internationally In Australia, Xero has partnered T recognised environmental and with Beyond Blue, an expert, not-for- conservation projects. profit provider of mental health initiatives, Global ESG rating agencies and sustainability which provides our team and partners in Australia rankings recognised Xero's efforts to positively access to resources to support their mental health. contribute to environmental and social impact as Xero donated funds to support the Red Cross well as maintain sustainable and ethical operations. Disaster Relief and Recovery fund to support those Xero was recognised in FTSE Russell ESG Rating impacted by Australian bushfires. FTSE4Good Index Series in 2019 and received an MSCI ESG Rating of A. We were also rated by Through our global employee volunteer program, RobecoSAM and ISS-oekom. Community Connect, Xero employees contributed more than 4,200 hours in support of their For information on Xero’s SEI initiatives and Net Zero communities this financial year. Every Xero employee @ Xero projects visit xero.com/socialimpact.
Xero named as a worldwide leader by the IDC MarketScape In April, Xero was recognised by the IDC The report also calls out the strengths of our open MarketScape as a leader in the market. The API strategy and machine learning for code-free IDC MarketScape recognised Xero as a Leader accounting, and the ecosystem of app partners
For personal use only use personal For for SaaS and Cloud-Enabled Small Business which provides small businesses with point Finance and Accounting Applications Vendors solutions to their needs. (doc #US45837020, April 2020). This recognition For more information please visit www.xero.com/ reflects the strength of Xero's strategy, product about/investors/idc-report. and service offerings and customer satisfaction. XERO LIMITED 13
The Board of Directors
David Thodey AO Mark was at Deutsche Bank for 10 years, CHAIR OF THE BOARD initially based in Sydney in Mergers and Acquisitions, then in London as a Managing Independent Director since June 2019 and Director and co-head of a European M&A Chair since February 2020 industry group. Mark holds a Bachelor of David is a business leader focused Business Studies (Accounting & Finance) on innovation, technology and degree from Massey University New Zealand, telecommunications, with more than 30 is a member of Chartered Accountants years of experience creating brand and Australia and New Zealand, a chartered shareholder value. He is currently chairman member of the New Zealand Institute of of Australia’s national scientific research Directors and a member of the Australian agency, the Commonwealth Scientific and Institute of Company Directors. Industrial Research Organisation (CSIRO), Audit and Risk Management Committee and Tyro, Australia’s only independent EFTPOS provider, a non-executive board director of Ramsay Health Care, a global Rod Drury hospital group; and of Vodafone Group Plc. XERO FOUNDER / NON-EXECUTIVE DIRECTOR David had a successful executive career as CEO of Telstra, a significant Australian Director since July 2006 telecommunications company and as CEO For more than a decade, Rod led Xero to of IBM Australia and New Zealand. In 2017, be a global software business and S&P/ David was made an Officer (AO) in the ASX 100 company. Rod started his career General Division of the Order of Australia. at Ernst & Young and went on to establish People and Remuneration Committee and lead a number of innovative technology Nominations Committee (Chair) businesses. Rod was an independent director on the NZX Board and the Trade Me Board. At the Deloitte Top 200 Awards in 2017, Rod Mark Cross was named Visionary Leader of the Year. NON-EXECUTIVE DIRECTOR He was named Ernst & Young New Zealand Entrepreneur of the Year in 2013, and is a Independent Director since April 2020 member of the New Zealand Hi-Tech Hall Mark is an experienced professional of Fame. director with more than 20 years of international experience in corporate finance and investment banking. Mark
is currently a non-executive director of For personal use only use personal For dual-listed ASX/NZX businesses Chorus and Z Energy and is Chair of Milford Asset Management. He is also a founding director of Virsae, a communications management SaaS business. 14 THE BOARD OF DIRECTORS
Lee Hatton Business, Innovation & Skills. She served on NON-EXECUTIVE DIRECTOR the Business Taskforce on EU Redtape for the British Prime Minister in 2013. Dale was Independent Director since April 2014 awarded a CBE by Her Majesty the Queen in Lee has over 20 years’ experience 2013, for services to business. internationally in the Financial Services Audit and Risk Management Committee industry and has held senior executive Nominations Committee roles in Marketing, Strategy, Risk and large scale customer-facing businesses. Lee was the Chief Executive Officer of Susan Peterson UBank (a digital bank in Australia) for NON-EXECUTIVE DIRECTOR five years, 2015 to 2020. Lee has been Independent Director since February 2017 recognised by IBM as one of 40 Women Leaders in Artificial Intelligence across the Susan is an experienced independent globe for her work in delivering world- director on both ASX and NZX listed first innovations. Lee holds a Bachelor companies. She is currently an independent of Business from Auckland University director of Trustpower, Vista Group, of Technology (NZ), and is an alumni of Property for Industry, and ASB Bank. Susan Berkeley Haas School of Business. She is is a member of the New Zealand Markets also a member of Chief Executive Women Disciplinary Tribunal, was a past Ministerial (CEW) which represents Australia’s most Appointee to The National Advisory Council senior and distinguished female leaders for the Employment of Women, and is a Board member of non-profit Global Women Audit and Risk Management Committee (NZ). Susan is founding co-chair and a (Chair) shareholder in fast-growing health and wellness start-up company Organic Dale Murray CBE Initiative Limited. NON-EXECUTIVE DIRECTOR People and Remuneration Committee (Chair) Independent Director since April 2018 Nominations Committee
Dale is a growth strategy consultant and former technology entrepreneur. Dale Craig Winkler co-founded mobile pioneer Omega Logic NON-EXECUTIVE DIRECTOR in 1999, which co-launched prepay top-ups Director since May 2009 in the UK. She led the growth of top-up transactions to £450m within five years, Craig co-founded Australian small business generating net revenue of £25 million. After accounting software provider MYOB in 1991. selling the company in a trade sale, she Craig built MYOB to be a popular business turned to investing and advising start- tool and brand which, in 2004, merged with ups and won the British Angel Investor of Solution 6 to become Australia’s largest IT the Year award in 2011. Dale is currently a company. Craig joined the Xero Board in Partner at Founders Intelligence Ltd, a non- 2009. He now spends the majority of his time
executive director at The Cranemere Group working in the philanthropic sector. For personal use only use personal For Ltd, and a board advisor to Accelerate:Her. People and Remuneration Committee She was formerly a non-executive director Nominations Committee and Trustee for the Peter Jones Foundation and a non-executive director at Sussex Place Ventures and the Department for XERO LIMITED 15
Management Commentary
You should read the following commentary with the consolidated financial statements and the related notes in this report. Some parts of this commentary include information regarding the plans and strategy for the business, and include forward- looking statements that involve risks and uncertainties. Actual results and the timing of certain events may differ materially from future results expressed or implied by the forward-looking statements contained in this commentary. All amounts are presented in New Zealand dollars (NZD) except where indicated. References to the period or FY20 are for the year ended 31 March 2020. References to the comparative period or FY19 are for the year ended 31 March 2019.
Non-GAAP measures have been included, as we believe they provide useful information for readers to assist in understanding Xero’s (the Group’s) financial performance. Non-GAAP financial measures should not be viewed in isolation or considered as substitutes for measures reported in accordance with New Zealand equivalents to International Financial Reporting Standards
(NZ IFRS). For personal use only use personal For 16 MANAGEMENT COMMENTARY
Business results
2020 2019 Year ended 31 March ($000s) ($000s) change
Subscription revenue 696,220 538,384 29% Other operating revenue 22,011 14,435 52% Total operating revenue 718,231 552,819 30% Cost of revenue (106,582) (90,915) 17% Gross profit 611,649 461,904 32% Gross margin percentage 85.2% 83.6% 1.6pp* Total operating expenses (580,090) (451,881) 28% Percentage of operating revenue 80.8% 81.7% -0.9pp Other income and expenses 2,550 (96) NM** Operating profit before asset impairments 34,109 9,927 244% Asset impairments (1,427) (18,604) -92% Operating profit/(loss) 32,682 (8,677) NM Percentage of operating revenue 4.6% -1.6% 6.2pp Net finance expense (22,845) (14,459) 58% Income tax expense (6,501) (4,007) 62% Net profit/(loss) 3,336 (27,143) NM Percentage of operating revenue 0.5% -4.9% 5.4pp
*pp stands for percentage points **NM stands for not meaningful
During FY20, Xero continued to execute its growth strategy delivering strong operating revenue growth of 30% while remaining focused on operational discipline. This was reflected in Xero’s first full year net profit after tax of $3.3 million, an improvement of $30.5 million compared to the $27.1 million loss in FY19. The net profit result was generated by ongoing growth in operating revenue coupled with improved gross margin performance and disciplined management of operating expenses. FY19 results were also impacted by $18.6 million of non-cash asset impairments compared to $1.4 million in FY20.
These results were impacted by the lockdowns that took effect across the world during March, late in Xero’s 2020 financial year. This meant the impact of COVID-19 on Xero’s operating and financial performance for the period was modest. The sales performance in March was subdued. A planned price increase in March (for the majority of Business Edition customers) was also deferred. As a result, our Business Edition customers now have access to Hubdoc as part of their plan at no extra cost.
Operating revenue growth was supported by subscriber growth in all markets. Xero reached a milestone in the first half of FY20, surpassing two million subscribers globally. 467,000 net subscribers were added during the period, bringing total subscribers to 2,285,000 at 31 March 2020.
Gross margin percentage improved by 1.6 percentage points compared to FY19. This was due to the realisation of continued efficiencies in the costs of hosting Xero’s cloud services and further productivity gains from Xero Central (Xero’s customer experience and community platform). Total operating expenses increased by 28% compared to the comparative period as Xero continued to invest in scaling its global business, developing new products, and driving quality subscriber growth.
For personal use only use personal For Total operating revenue growth of 30% exceeded growth in total operating expenses, resulting in improved operating profit before asset impairments of $34.1 million in FY20, up $24.2 million from $9.9 million in FY19.
Depreciation and amortisation (which is included in costs of revenues and operating expenses) increased by $23m, or 28%, compared to FY19. This was in line with operating expenses increasing by 28%. This was due to an increase in intangible asset balances and increased depreciation due to additional office space.
The increase in net finance expense of $8.4 million was primarily driven by incurring a full year of interest costs associated with the convertible notes issued in October 2018, compared to six months of such costs incurred in FY19. XERO LIMITED 17
Earnings before interest, tax, depreciation, and amortisation (EBITDA)
EBITDA disclosures (which are non-GAAP financial measures) have been included, as we believe they provide useful information for readers in understanding Xero’s financial performance. EBITDA is calculated by adding back depreciation, amortisation, net finance expense, and income tax expense to net profit/loss.
2020 2019 Year ended 31 March ($000s) ($000s) change
Net profit/(loss) 3,336 (27,143) NM Add back: net finance expense 22,845 14,459 58% Add back: depreciation and amortisation 105,061 81,848 28% Add back: income tax expense 6,501 4,007 62% EBITDA 137,743 73,171 88% EBITDA margin 19.2% 13.2% 6.0pp
EBITDA improved by $64.6 million or 88% in FY20 compared to FY19, resulting in EBITDA as a percentage of revenue increasing from 13.2% in FY19 to 19.2% in FY20. FY19 EBITDA was affected by $18.6 million of asset impairments. The improvement in FY20 EBITDA was primarily driven by revenue growth of 30% compared to FY19, as the business continues to deliver the benefits of scale. Operational efficiencies were delivered across the cost of revenue, sales and marketing, and product design and development functions, as total operating expenses as a proportion of operating revenue decreased to 80.8%, compared to 81.7% in FY19.
EBITDA excluding the impact of non-cash share-based payments and impairments (a non-GAAP financial measure) is provided as we believe it provides useful information to analyse trends in cash-based expenses.
2020 2019 Year ended 31 March ($000s) ($000s) change
EBITDA 137,743 73,171 88% Add back: non-cash share-based payments 34,336 28,946 19% Add back: non-cash impairments 1,427 18,604 -92% EBITDA excluding non-cash share-based payments and impairments 173,506 120,721 44% Percentage of operating revenue 24.2% 21.8% 2.4pp
EBITDA excluding non-cash share-based payments and non-cash impairments for FY20 was $173.5 million, an improvement of $52.8 million or 44% compared to FY19. Operating revenue growth of 30% exceeded growth in included cash-based expenses of 26%. This resulted in EBITDA excluding non-cash share-based payments and impairments improving as a percentage of
operating revenue by 2.4 percentage points. For personal use only use personal For 18 MANAGEMENT COMMENTARY
Cash flows and liquidity
Free cash flow is a non-GAAP financial measure that has been included to show readers net cash generated by, and invested into, the business. We define free cash flow as cash flows generated from operating activities less cash flows used for investing activities, excluding cash used for acquisitions of, and investments into, businesses and strategic assets.
2020 2019 Year ended 31 March ($000s) ($000s) change
Receipts from customers 717,264 552,256 30% Other operating cash flows (550,635) (438,030) 26% Total cash flows from operating activities 166,629 114,226 46% Investing activities (139,524) (140,471) -1% Add back: acquisitions – 32,696 -100% Free cash flows 27,105 6,451 320%
Free cash flows for FY20 increased by $20.7 million to $27.1 million, equating to 3.8% of total operating revenue, compared to $6.5 million or 1.2% of total operating revenue in FY19.
Receipts from customers increased by 30% or $165.0 million to $717.3 million which is aligned with operating revenue growth of 30%. Cash flows from operating activities increased by $52.4 million to $166.6 million as receipts from customers grew at a faster rate (30%) than other operating cash flows (26%, primarily due to payments to suppliers and employees).
Cash outflows from investing activities, excluding acquisitions, increased by 29% or $31.7million. The increase was largely driven by higher capitalised spend on product design and development, which increased by $29.0 million or 39% compared to FY19.
Free cash flows
$25m
$0
($25m)
($50m)
($75m) FY17 FY18 FY19 FY20
Total available liquidity (defined as cash and cash equivalents, short-term deposits including proceeds from convertible notes,
For personal use only use personal For and undrawn committed debt facilities) at 31 March 2020 was $686.1 million. This comprised $536.1 million of cash and cash equivalents and short-term deposits as well as access to an undrawn committed debt facility of $150.0 million. Of the cash and cash equivalents and short-term deposits balance, $410.5 million relates to the convertible note proceeds that are held in USD for future strategic investments and acquisitions. None of Xero’s term debt nor the standby debt facility matures in the next 24 months.
During FY20, Xero refinanced its standby debt facility for a three year term and upsized it to $150.0 million, an increase from $100.0 million. The lender group was expanded from two to four banks, with existing lenders BNZ and ANZ joined by global banks HSBC and Citibank. This facility is in place to ensure Xero maintains access to prudent levels of operational liquidity, appropriate to the size and maturity of the business. XERO LIMITED 19
Operating revenue
Subscription revenue comprises recurring monthly fees from subscribers to Xero’s cloud-based platform. Within a subscription, customers also receive support services and product updates.
Operating revenue includes subscription revenue as well as revenue from other related services, including attendance fees for conferences and events such as Xerocon, revenue share agreements with financial services providers including fintech, and the implementation of online accounting and other software services. Subscription revenue comprises 97% of operating revenue in FY20.
2020 2019 change in Year ended 31 March ($000s) ($000s) change constant currency*
Subscription revenue 696,220 538,384 29% 29% Other operating revenue 22,011 14,435 52% 50% Total operating revenue 718,231 552,819 30% 29%
*constant currency operating revenue (a non-GAAP financial measure) is provided to assist readers in understanding and assessing Xero’s financial performance during the year, excluding the impact of foreign currency fluctuations. Constant currency operating revenue is calculated by translating operating revenue for FY20 at the effective exchange rates for FY19.
Operating revenue growth of 30% from FY19 was a key driver of Xero’s first full year profit. This was driven by subscriber growth, increased uptake of Xero add-ons, and growth in other operating revenue.
Subscription revenue increased by 29%, primarily driven by organic subscriber growth. Subscriber numbers at 31 March 2020 increased by 26%, or 467,000, compared to 31 March 2019. In addition, uptake of Xero add-ons such as payroll, projects and expenses modules was higher, contributing to the subscription revenue increase.
Other operating revenue increased by 52% as a result of two major contributing components, fintech partnerships and conference revenue. Xerocon conference revenue increased by 29% compared to FY19. Xero partners with fintech providers to offer online financial solutions to subscribers, resulting in an associated share of revenue between the provider and Xero. Other operating revenue excluding conference income increased by 73% compared to FY19.
As 84% of Xero’s operating revenue is denominated in currencies other than NZD (the Group’s functional currency), changes in foreign exchange rates over the year have influenced reported revenue. The impact of the comparatively stronger NZD against the Australian dollar (AUD) was more than offset by the impacts of the weaker NZD against the US dollar (USD) and Great British pound (GBP) during FY20 compared to FY19. This resulted in constant currency operating revenue for the Group being $3.3
million lower than reported revenue. For personal use only use personal For 20 MANAGEMENT COMMENTARY
Operating revenue by geography
2020 2019 change in Year ended 31 March ($000s) ($000s) change constant currency
Australia 320,376 261,468 23% 25% New Zealand 116,154 97,639 19% 19% Australia and New Zealand (ANZ) total 436,530 359,107 22% 23% United Kingdom 183,565 119,521 54% 50% North America 55,398 44,270 25% 19% Rest of World 42,738 29,921 43% 36% International total 281,701 193,712 45% 41% Total operating revenue 718,231 552,819 30% 29%
Operating revenue growth in all geographies is underpinned by continued subscriber growth. In the ANZ market, operating revenue grew by 22%, exceeding the 21% growth in subscribers shown in the next section. With the high level of penetration into the ANZ market, Xero’s continued revenue growth in this market is encouraging.
The Australian market’s operating revenue grew by 23% compared to subscriber growth of 26%. This was primarily due to the strengthening of the NZD against the AUD during FY20 (with constant currency revenue growth of 25%). Additional factors were the release of lower-priced, payroll-only plans to support the Single Touch Payroll initiative recently introduced by the ATO, and the further extension into existing partner practices with lower ARPU products.
New Zealand operating revenue increased by 19%, comparatively faster than subscriber growth of 12%. This was due to positive movement in product mix and further uptake in platform-related products, such as payroll, and growth of revenue from fintech partnerships.
For the first time, revenue growth in the International segment of $88.0 million, exceeded revenue growth in the more established ANZ market ($77.4 million). Operating revenue in the UK grew by 54% compared to FY19, as Xero was well positioned to benefit from HM Revenue & Customs’ (HMRC) Making Tax Digital initiatives. Operating revenue in North America grew by 25% while the Rest of World markets grew by 43%. The Rest of World’s performance was driven by subscriber growth of 51%, with South Africa and Singapore the largest contributing markets.
Reported revenue benefited from fluctuations in the foreign exchange rates, specifically the NZD being weaker against both the GBP and USD on average during FY20 compared to FY19. In constant currency, operating revenue for the International segment is $273.0 million, $8.7 million or 3.1% lower than reported revenue.
Total Group operating revenue by geography*
$800m
Rest of World North America $600m United Kingdom
$400m New Zealand For personal use only use personal For
$200m Australia
0 FY17 FY18 FY19 FY20
*represents each region's contribution to total Group operating revenue for the respective period XERO LIMITED 21
Subscriber numbers
The definition of ‘subscriber’ is: Each unique subscription to a Xero-offered product that is purchased by a user (e.g. small business or accounting partner) and which is, or is available to be, deployed. Subscribers that have multiple subscriptions to integrated products on the Xero platform are counted as a single subscriber.
At 31 March 2020 2019 change
Australia 914,000 726,000 26% New Zealand 392,000 351,000 12% Australia and New Zealand (ANZ) total 1,306,000 1,077,000 21% United Kingdom 613,000 463,000 32% North America 241,000 195,000 24% Rest of World 125,000 83,000 51% International total 979,000 741,000 32% Total paying subscribers 2,285,000 1,818,000 26%
Subscribers grew by 26% compared to 31 March 2019, bringing total subscribers to 2,285,000. Subscriber additions continue to grow, with 467,000 net subscribers added in FY20 compared to 432,000 in FY19. This is the largest subscriber increase in a financial year since Xero’s inception in 2006. For the second year in a row, more subscribers were added in the International markets than in ANZ with 238,000 subscribers added in International, compared to 229,000 in ANZ. The impacts of Covid-19 resulted in less than expected subscriber additions in the last month of the year. The UK in particular was impacted to a greater extent in March than Xero's other markets.
Xero continued to increase its presence in the established ANZ market, growing subscribers by 21%, or 229,000, compared to FY19. Xero’s position as market leader in Australia was further solidified as Xero added 188,000 subscribers in FY20 to reach 914,000 subscribers. This result was assisted by the ATO’s Single Touch Payroll initiative, which requires businesses to submit payroll reports digitally. Xero released a new payroll-only product in Australia to assist small businesses in their preparation for the new legislative requirements, which is also proving an integral tool for access to COVID-19 government stimulus benefits. While more developed, New Zealand remains a growth market for Xero as it added another 41,000 subscribers, representing a 12% increase.
The UK led the International segment, adding 150,000 subscribers in FY20 to end on 613,000 subscribers, an increase of 32%. The UK performance continued to benefit from HMRC’s Making Tax Digital initiatives under which businesses require software to process VAT returns and digitise their financial and other business records.
North American subscriber numbers increased by 24%, or 46,000, from the comparative period, the highest annual net organic additions to date. This performance is an early sign of progress from the partner channel strategy across North America.
Rest of World markets also performed strongly with 51% growth in subscribers in FY20. These numbers reflect Xero’s adoption across a number of regions, with South Africa and Singapore continuing to gain traction.
Net subscriber additions FY20 FY19
For personal use only use personal For Australia
New Zealand 32.1% 34.9% 33.1% United Kingdom 467k 40.3% 432k North America
9.8% 11.6% Rest of World 14.6% 9.0% 8.8% 5.8% 22 MANAGEMENT COMMENTARY
Annualised monthly recurring revenue
Annualised monthly recurring revenue (AMRR) is a non-GAAP financial measure, which represents monthly recurring revenue at 31 March multiplied by 12. It provides a 12-month forward view of revenue, assuming any promotions have ended and other factors such as subscriber numbers, transaction volumes, pricing, and foreign exchange remain unchanged during the year.
Constant currency AMRR (also a non-GAAP financial measure) is calculated by translating AMRR at 31 March 2020 at the foreign exchange rates at 31 March 2019, and is provided to assist in understanding and assessing year-on-year growth rates, excluding the impact of foreign currency fluctuations.
2020 2019 change in At 31 March ($000s) ($000s) change constant currency
ANZ 467,537 396,233 18% 19% International 353,020 241,946 46% 33% Total 820,557 638,179 29% 25%
Total Group – AMRR surpassed $800 million during the year, ending FY20 at $820.6 million - up $182.4 million, or 29%, from 31 March 2019. Growth of AMRR was principally driven by subscriber growth in all regions. In constant currency terms, total AMRR grew by 25%, due to subscriber growth of 26% offset by a 1% decrease in constant currency ARPU. The impact of Covid-19 on March trading, with fewer subscriber additions, resulted in less than expected AMRR growth for the month. Of particular impact to AMRR was the decision to defer a planned price rise for business edition subscribers for all regions except the UK. While the lower than expected AMRR growth had little impact on FY20 operating revenue, revenue in FY21 will be impacted to a greater extent.
ANZ – Continued subscriber growth of 21% drove AMRR, which increased 18% to $467.5 million. Constant currency AMRR growth was 1 percentage point higher than reported growth, due to the stronger NZD against the AUD at 31 March 2020 compared to 31 March 2019.
International – AMRR growth in the International markets was 46%, driven by growth in subscriber numbers (32%) and the impact of foreign exchange. The weaker NZD against the USD and GBP at 31 March 2020 compared to 31 March 2019 had a favourable impact on reported AMRR for the International segment. Constant currency AMRR growth was 33%, slightly ahead of
subscriber growth due in part to a price change in the UK market. For personal use only use personal For XERO LIMITED 23
Gross profit
Gross profit represents operating revenue less cost of revenue. Cost of revenue consists of expenses directly associated with securely hosting Xero’s services, sourcing relevant data from financial institutions, and providing support to subscribers.
The costs include hosting and content distribution costs, bank feed costs, personnel and related expenses (including salaries, benefits, bonuses, and share-based payments) directly associated with cloud infrastructure and subscriber support, contracted third-party vendor costs, related depreciation and amortisation, and allocated overheads.
2020 2019 Year ended 31 March ($000s) ($000s) change
Operating revenue 718,231 552,819 30% Cost of revenue (106,582) (90,915) 17% Gross profit 611,649 461,904 32% Gross margin percentage 85.2% 83.6% 1.6pp
Gross margin increased by 1.6 percentage points to reach 85.2% for FY20. This was driven by operating revenue growth of 30%, as well as efficiencies in cost of revenue. This resulted in gross profit increasing by $149.7 million, or 32%, to $611.6 million. Cost of revenue for FY20 grew by $15.7 million to $106.6 million, representing a 17% increase when compared to FY19. The primary reasons for the change in cost of revenue were increases in personnel costs related to higher headcount in Xero’s customer support teams, and increased cloud hosting costs.
Growing use of Xero Central (launched in FY19) and hosting cost efficiencies were the main drivers of improvement in gross margin. There has been an emphasis on customer self-service with the aid of machine learning, via Xero Central, which has helped offset the need for additional customer experience headcount as we continue to scale. Xero has also realised efficiencies in hosting through optimising the Amazon Web Services (AWS) product mix and reducing wastage by scaling resources to reflect actual user load at any given time.
Gross margin percentage
85.0%
80.0%
For personal use only use personal For 75.0% FY17* FY18 FY19 FY20
*affected by AWS migration 24 MANAGEMENT COMMENTARY
Sales and marketing
Sales and marketing expenses consist of personnel and related expenses (including salaries, benefits, bonuses, the amortisation of capitalised commission costs, and share-based payments) directly associated with the sales and marketing teams, and the cost of educating and onboarding both partners and small business customers. Costs also include relationship management costs incurred to support the existing subscriber base. Other costs included are external advertising costs, marketing costs and promotional events, as well as allocated overheads.
2020 2019 Year ended 31 March ($000s) ($000s) change
Sales and marketing expenses 312,852 248,014 26% Percentage of operating revenue 43.6% 44.9% -1.3pp
Sales and marketing costs increased by $64.8 million, or 26%, to $312.9 million for FY20, compared to operating revenue growth of 30%. The majority of sales and marketing costs are incurred in acquiring new subscribers and are expensed in the period, in contrast to the associated revenue from those subscribers, which is recognised over the life of the subscriber (typically more than seven years).
Sales and marketing spend has increased as Xero continues to pursue subscriber growth in all regions. Campaigns to drive sales in Australia and the UK, to take advantage of the Single Touch Payroll and Making Tax Digital initiatives, accounted for a significant share of investment in sales and marketing costs in the period. These contributed towards strong net subscriber additions in both countries, 26% in Australia and 32% in the UK.
The average cost of acquiring a subscriber increased to $420 per gross subscriber added in FY20 compared to $397 in FY19. This reflects the increasing globalisation of Xero’s subscriber mix with an increased contribution to our subscriber growth from the less developed markets within our International segment.
As a percentage of operating revenue, sales and marketing costs decreased from 44.9% in FY19 to 43.6% in FY20. While an improvement as a percentage of revenue, which shows increased efficiency, the significant continued investment in sales and marketing reflects the intention to reinvest cash back into the business to deliver on Xero’s strategic priorities, realising benefits
in future years. For personal use only use personal For XERO LIMITED 25
Product design and development
Product design and development costs consist primarily of personnel and related expenses (including salaries, benefits, bonuses, and share-based payments) directly associated with product design and development teams, as well as allocated overheads.
The proportion of product design and development expenses that creates a benefit in future years and meets certain requirements under NZ IFRS is capitalisable as an intangible asset and is then amortised to the Income Statement over the estimated life of the asset created. The amount amortised relating to the Xero product and platform is included as a product design and development expense.
2020 2019 Year ended 31 March ($000s) ($000s) change Total product design and development costs (including amounts capitalised)* 225,756 170,946 32% Percentage of operating revenue 31.4% 30.9% 0.5pp Less capitalised development costs (102,621) (73,598) 39% Product design and development expense (excluding amortisation of amounts capitalised) 123,135 97,348 26% Less government grants (5,164) (5,219) -1% Add amortisation of capitalised development costs 60,287 45,666 32% Product design and development expenses 178,258 137,795 29% Percentage of operating revenue 24.8% 24.9% -0.1pp
*excludes impairments
Xero continues to invest in its product and platform, developing and deploying a significant range of features in FY20 including:
- Xero Tax in the UK digitally prepares and files accounts and tax returns more efficiently, with an end-to-end integration with HMRC
- Xero HQ VAT in the UK supports managing Making Tax Digital compliance by providing accountants and bookkeepers oversight over VAT filings
- Xero HQ Payroll provides deeper insights for accountants and bookkeepers, which helps them support their clients by providing a single aerial view and insights over their clients' payroll. This also allows visibility in Australia on clients' Single Touch Payroll status
- The Hubdoc product is now included globally in Business Edition plans with a streamlined set up, single sign-on, and access from within Xero
- Xero NAB payments is a feature that provides a seamless and secure process for small businesses to pay and approve multiple bills from Xero’s real-time integrated platform. This is provided in partnership with leading Australian bank NAB
- Our strategic partnership and product integration with Stripe enables new payment experiences including a new Stripe feed and auto pay feature
- Short-term cash flow and Business Snapshot are two pilots underway that give small businesses deeper insights into their future cash flow and important trends
- Single Sign-On is a new, seamless and secure way for developers to build on the Xero platform, onboard new users without
making them remember more passwords, and integrate Xero with certified third-party apps more easily For personal use only use personal For - Advisor-powered app recommendations allows advisors to curate the Marketplace to ensure businesses get a tailored experience to help source the right tools and apps for them 26 MANAGEMENT COMMENTARY
Total product design and development costs were $225.8 million in FY20, $54.8 million or 32% higher than in FY19. Of this, $102.6 million was capitalised, with the balance of $123.1 million included in the Income Statement within total product design and development expenses. The amount capitalised represents a capitalisation rate of 45.5% of total product design and development costs for FY20, which is 2.4 percentage points higher than FY19.
As a proportion of operating revenue, total product design and development costs for FY20 (including amounts capitalised) increased by 0.5 percentage points to 31.4%. This highlights the continued investment in Xero’s global platform as product design and development costs keep pace with revenue growth.
The amortisation of previously capitalised product design and development expenditure of $60.3 million was included as a non-cash expense in the Income Statement, giving total net expenses (after the netting of government grants) of $178.3 million for FY20. Amortisation of previously capitalised development costs increased due to higher intangibles balances than in FY19.
General and administration
General and administration expenses consist of personnel and related expenses (including salaries, benefits, bonuses, and share-based payments) for executive, finance, billing, legal, human resources, strategy, corporate development, and administrative employees, and the Xero Board. It also includes legal, accounting and other professional services fees, insurance premiums, other corporate expenses, and allocated overheads.
2020 2019 Year ended 31 March ($000s) ($000s) change
General and administration expenses 88,980 66,072 35% Percentage of operating revenue 12.4% 12.0% 0.4pp
General and administration costs were $89.0 million for FY20, $22.9 million or 35% higher than FY19. This is due to the growth in personnel related expenses as Xero continues to scale. In particular, investment was made in building out strategy and corporate development functions to enable future growth.
General and administration costs as a proportion of operating revenue remained consistent with FY19, increasing 0.4 percentage
points to 12.4%. For personal use only use personal For XERO LIMITED 27
Employees
At 31 March 2020 2019 change
Total Group 3,055 2,531 21%
Full-time equivalent (FTE) employees increased by 524 or 21% in FY20, taking the total FTEs to 3,055. This is compared to a 26% increase in subscribers and 30% increase in operating revenue. The slower growth in FTEs compared to revenue and subscribers reflects the benefits of economies of scale and operating efficiencies, while investment continues to be made in sales and marketing as well as product design and development.
Net finance expense
2020 2019 Year ended 31 March ($000s) ($000s) change
Interest income on deposits 13,432 8,035 67% Total finance income 13,432 8,035 67% Interest on convertible notes (28,033) (12,753) 120% Bank standby facility costs (1,691) (1,847) -8% Lease liability interest (6,280) (4,987) 26% Other finance expense (273) (2,907) -91% Total finance expense (36,277) (22,494) 61% Net finance expense (22,845) (14,459) 58%
Finance income in FY20 was $13.4 million, an increase of $5.4 million from the comparative period. This was due to a significant increase in cash and short-term deposit balances from the issue of convertible notes in October 2018, being held for all of FY20 compared to six months of FY19. Proceeds from the convertible notes issue remain largely undeployed and are held on deposit until required.
Finance expense increased by 61%, driven by interest on the convertible notes combined with lease liability interest. Of the $28.0 million of interest on convertible notes, $11.0 million relates to coupon payments, a cash cost, and the remainder being the non-cash amortisation of the related debt liability discount. Lease liability interest increased by $1.3 million, largely due to the lease of Xero’s Auckland office, which was entered into during the second half of FY19. Net cash finance costs, cash interest
income less cash interest expense, were $5.1 million compared to $4.5 million in FY19. For personal use only use personal For 28 MANAGEMENT COMMENTARY
Segment information
Operating revenue is allocated to a segment depending on where the subscriber resides. Expenses include cost of revenue, sales and marketing costs incurred directly in-region, and an allocation of centrally managed costs and overheads, such as hosting and user support costs.
ANZ International Total ($000s) ($000s) ($000s)
Year ended 31 March 2020 Operating revenue 436,530 281,701 718,231 Expenses (164,962) (254,472) (419,434) Segment contribution 271,568 27,229 298,797 Contribution margin percentage 62.2% 9.7% 41.6%
Year ended 31 March 2019 Operating revenue 359,107 193,712 552,819 Expenses (140,175) (198,754) (338,929) Other income 69 331 400 Segment contribution 219,001 (4,711) 214,290 Contribution margin percentage 61.0% -2.4% 38.8%
ANZ - Operating revenue for FY20 grew by 22% compared to the comparative period, further reinforcing Xero’s market leading position in the region. Australia led the growth in this segment as the ATO’s Single Touch Payroll initiative contributed to strong demand for cloud accounting and payroll-specific solutions. Constant currency operating revenue grew by 23% compared to the comparative period. This exceeded the 21% growth in subscribers, largely due to the timing of new subscriber additions, with more subscribers added in the first half of the year than the second half.
The operating revenue growth, along with continued cost efficiencies, resulted in an FY20 segment contribution of $271.6 million. This was an increase of 24% on FY19 and represents 62.2% of operating revenue, up from 61.0% in the comparative period. Across the ANZ segment, 229,000 net subscribers were added during FY20, a new record for this segment.
International - Operating revenue for FY20 grew by 45%, or 41% in constant currency, largely due to subscriber growth of 32%. Revenue growth exceeded subscriber growth due to a UK price increase during H1 FY20, along with the annualised revenue benefit of strong subscriber growth in H2 FY19, which benefited from the rollout of Making Tax Digital for VAT. The International segment had a positive segment contribution in FY20 of $27.2 million, compared to a contribution loss of $4.7 million in FY19. This is the first positive full year contribution for the International segment.
As a percentage of revenue, the contribution margin improved from -2.4% to 9.7%. This was due to strong revenue growth, combined with scaling and efficiencies, particularly in the UK. The contribution margin remained comparatively lower than that of ANZ, reflecting the emphasis on investment in growing subscriber additions in the UK, North America, Asia, and South Africa, as
Xero continues to develop brand recognition and build distribution channels in these markets. For personal use only use personal For XERO LIMITED 29
Key SaaS Metrics
SaaS companies like Xero operate on many of the same performance metrics as traditional companies, such as revenue, cash flow, and customer numbers. However, understanding the performance of SaaS companies and being able to benchmark them is assisted by an understanding of SaaS-specific metrics. Below are some of the headline metrics we use to manage and drive Xero’s performance.
Average revenue per user (ARPU) is calculated as AMRR (see definition on page 22) at 31 March, divided by subscribers at that time (and divided by 12 to get a monthly view).
CAC months are the months of ARPU to recover the cost of acquiring (customer acquisition costs: CAC) each new subscriber. The calculation represents the sales and marketing costs for the year excluding the capitalisation and amortisation of contract acquisition costs, less conference revenue (such as Xerocon), divided by gross new subscribers added during the same period, divided by ARPU.
Churn is the value of monthly recurring revenue (MRR) from subscribers who leave Xero in a month as a percentage of the total MRR at the start of that month. The percentage provided is the average of the monthly churn for the previous 12 months.
Lifetime value (LTV) is the gross margin expected from a subscriber over the lifetime of that subscriber. This is calculated by taking the average subscriber lifetime (one divided by churn), multiplied by ARPU, multiplied by the gross margin percentage. Group LTV is calculated as the sum of the individual segment LTV, multiplied by their respective segment subscribers, divided by total Group subscribers.
LTV/CAC is the ratio between the LTV and the cost to acquire that subscriber. For example, the LTV derived from a subscriber in ANZ is currently on average 10.6 times the cost of acquiring that subscriber.
We strive to maximise total LTV while optimising the level of CAC investment we undertake in order to achieve a desirable LTV/ CAC ratio. We can improve total LTV in multiple ways, such as increasing subscriber numbers, enhancing products and services for existing subscribers thereby increasing ARPU and/or reducing churn, and improving gross margin through cost efficiencies.
The table below outlines key metrics across Xero’s segments:
At 31 March 2020 ANZ International Total
ARPU ($) 29.83 30.05 29.93 CAC months 9.7 18.1 14.0 Churn 0.84% 1.59% 1.13% LTV per subscriber ($) 3,058 1,573 2,422 LTV/CAC 10.6 2.9 5.8
At 31 March 2019 ANZ International Total
ARPU ($) 30.66 27.21 29.25 CAC months 9.4 18.3 13.6 Churn 0.85% 1.55% 1.10% LTV per subscriber ($) 3,075 1,413 2,398
LTV/CAC 10.7 2.8 6.0 For personal use only use personal For 30 MANAGEMENT COMMENTARY
ANZ – ARPU within the ANZ segment decreased by 3% compared to 31 March 2019. This was largely due to the launch of Single Touch Payroll focused products in Australia during FY20, with a lower associated ARPU, as well as a weaker AUD against the NZD at 31 March 2020 compared to 31 March 2019. This was partially offset by increases in ARPU within New Zealand, driven by a greater emphasis on add on solutions such as Xero Payroll, which benefited from the introduction of payday filing by Inland Revenue on 1 April 2019.
In constant currency terms, ANZ ARPU decreased 2% to $30.19 compared to $30.66 at 31 March 2019. CAC months at 31 March 2020 was moderately higher than at 31 March 2019 as Xero continues to invest in its small business platform, ecosystem and fintech strategies that target existing customers, as well as investing to drive growth to further increase market share in the ANZ segment.
The decrease in ARPU, offset by improved gross margin and lower churn, led to a 1% decrease in LTV per subscriber (a 1% increase in constant currency) within ANZ. Total ANZ subscriber LTV increased by $0.7 billion, or 21% to $4.0 billion at 31 March 2020 compared to $3.3 billion at 31 March 2019.
International – ARPU across the International segment increased by 10% (1% in constant currency) from 31 March 2019. A price increase in the UK for Standard and Premium pricing plans in August 2019 had a favourable impact on UK ARPU.
The comparatively stronger USD against the NZD also had a positive effect on ARPU within North America and Rest of World. This was partially offset by a shift towards the more efficient but lower ARPU partner channel in these markets.
Improvements in ARPU resulted in the decline in CAC months from 18.3 months to 18.1 months. This was despite increased sales and marketing costs in this segment contributing to a 9% increase in the cost of acquiring each new subscriber (a 6% increase in constant currency) compared to the comparative period.
LTV per subscriber improved by 11% at 31 March 2020 compared to the comparative period (an increase of 1% in constant currency), due to higher gross margin and ARPU, despite a slight increase in churn. Total LTV for the International segment increased by 47% to $1.5 billion (34% in constant currency) at 31 March 2020 compared to 31 March 2019 due to subscriber growth, particularly in the UK market.
Total Group – Group ARPU increased by 2% compared to 31 March 2019. This was due to increases in pricing in the UK, and the impact of favourable foreign currency movements in the USD and GBP. ARPU decreased 1% in constant currency compared to 31 March 2019.
LTV per subscriber increased 1% from the same time last year to $2,422, primarily due to improvements in gross margin and ARPU, while churn was slightly higher than FY19. Group constant currency LTV per subscriber at 31 March 2020 was 1% lower than at 31 March 2019.
Total subscriber LTV at 31 March 2020 was $5.5 billion, an improvement of more than $1.1 billion compared to 31 March 2019. CAC months increased 3% to 14.0 months when compared to 31 March 2019, due to a 6% increase in the cost of acquiring each new subscriber. This was despite an ARPU increase in actual currency.
Total lifetime value
$6b International
$5b ANZ
$4b For personal use only use personal For $3b
$2b
$1b
$0 2017 2018 2019 2020 At 31 March XERO LIMITED 31
Financial Statements
Independent auditor’s report 32
Financial Statements 36 Income Statement 36 Statement of Comprehensive Income 36 Statement of Financial Position 37 Statement of Changes in Equity 38 Statement of Cash Flows 39
Notes to the Financial Statements 40
General information 1. Reporting entity and statutory base 40 2. Basis of accounting 40
Performance 3. Segment information 41 4. Revenue 42 5. Expenses 43 6. Finance income and expense 44 7. Earnings per share 45
Operating assets and liabilities 8. Trade and other receivables 46 9. Property, plant and equipment 47 10. Intangible assets 48 11. Trade and other payables 50 12. Other current liabilities 50 13. Lease liabilities 51
Funding and risk 14. Term debt 51 15. Financial instruments, capital and financial risk management 52 16. Derivatives and hedge accounting 59 17. Share capital 61
Group structure 18. Group entities 62
Other information 19. Current and deferred income tax 63 20. Reconciliation of operating cash flows 65 21. Changes in financial assets and liabilities For personal use only use personal For arising from financing activities 66 22. Share-based payments 66 23. Key management personnel and related parties 69 24. Commitments and contingencies 69 25. Events after balance sheet date 69
Directors' responsibilities statement 70 32 INDEPENDENT AUDITOR'S REPORT
Independent auditor's report to the Shareholders of Xero Limited
Report on the audit of the financial statements
OPINION We have audited the financial statements of Xero Limited We believe that the audit evidence we have obtained is (“the company”) and its subsidiaries (together “the Group”) sufficient and appropriate to provide a basis for our opinion. on pages 36 to 69, which comprise the consolidated statement Ernst & Young has provided R&D tax credit advice and other of financial position of the Group as at 31 March 2020, assurance services related to the Group’s compliance with ISO and the consolidated statement of comprehensive income, 27001. Partners and employees of our firm may deal with the consolidated statement of changes in equity and consolidated Group on normal terms within the ordinary course of trading statement of cash flows for the year then ended of the Group, activities of the business of the Group. Ernst & Young uses the and the notes to the consolidated financial statements Group’s platform in delivering services to some clients. We including a summary of significant accounting policies. have no other relationship with, or interest in, the Group. In our opinion, the consolidated financial statements on pages 36 to 69 present fairly, in all material respects, the Key audit matters consolidated financial position of the Group as at 31 March Key audit matters are those matters that, in our professional 2020 and its consolidated financial performance and cash judgment, were of most significance in our audit of the flows for the year then ended in accordance with New Zealand consolidated financial statements of the current year. These equivalents to International Financial Reporting Standards and matters were addressed in the context of our audit of the International Financial Reporting Standards. consolidated financial statements as a whole, and in forming our opinion thereon, but we do not provide a separate opinion This report is made solely to the company’s shareholders, on these matters. For each matter below, our description of as a body. Our audit has been undertaken so that we might how our audit addressed the matter is provided in that context. state to the company’s shareholders those matters we are required to state to them in an auditor’s report and for no We have fulfilled the responsibilities described in the Auditor’s other purpose. To the fullest extent permitted by law, we do responsibilities for the audit of the financial statements section not accept or assume responsibility to anyone other than the of the audit report, including in relation to these matters. company and the company’s shareholders, as a body, for Accordingly, our audit included the performance of our audit work, for this report, or for the opinions we procedures designed to respond to our assessment of the risks have formed. of material misstatement of the financial statements. The results of our audit procedures, including the procedures Basis for opinion performed to address the matters below, provide the basis for We conducted our audit in accordance with International our audit opinion on the accompanying consolidated Standards on Auditing (New Zealand). Our responsibilities financial statements. under those standards are further described in the Auditor’s Responsibilities for the Audit of the Financial Statements section of our report.
We are independent of the Group in accordance with
For personal use only use personal For Professional and Ethical Standard 1 (revised) Code of Ethics for Assurance Practitioners issued by the New Zealand Auditing and Assurance Standards Board, and we have fulfilled our other ethical responsibilities in accordance with these requirements. XERO LIMITED 33
Capitalised Software Development Costs including impairment
Why significant How our audit addressed the key audit matter
Intangible assets make up 79% of the Group’s non-current Our work on capitalised development costs focused on the assets. The most significant of these intangible assets is Group’s process for estimating the time spent by staff on capitalised software development costs. software development that can be capitalised under NZ IAS 38: Intangible Assets. The Group capitalises costs incurred in the development of its software. These costs are then amortised over the estimated Our audit procedures included the following: useful life of the software. • Assessing the nature of a sample of projects against the The Group’s process for calculating the value of internally requirements of NZ IAS 38 to determine if they were capital developed software involves judgment as it includes in nature; estimating time which staff spend developing software and • Assessing the procedures applied by the Group to review determining the value attributable to that time. the rates applied to capitalise payroll costs; NZ IAS 36: Impairment of Assets requires that finite life • Assessing the effectiveness of controls over the processing intangible assets be tested for impairment whenever there is of payroll costs; an indication that the intangible assets may be impaired. This assessment requires judgment including consideration of both • Assessing capitalised costs with reference to actual payroll internal and external sources of information. information for a sample of employees;
Disclosures relating to Intangible Assets, including key We assessed the factors that the Group considered regarding assumptions, are included in Note 10 to the consolidated impairment of capitalised development costs and whether any financial statements. indicators of impairment existed. This included having regard to:
• Significant changes in the extent or manner in which the associated software is used;
• Potential or actual redundancy or disposal of developed software;
• Amortisation periods applied by the Group to developed software relative to its experience of software lifecycle;
• Significant changes in the market in which the assets are used; and
We assessed the adequacy of the disclosures related to capitalised development costs and related impairment
considerations in the consolidated financial statements. For personal use only use personal For 34 INDEPENDENT AUDITOR'S REPORT
Goodwill impairment testing
Why significant How our audit addressed the key audit matter
The Group recognises $78.8 million of goodwill related to the We assessed the Group’s judgements in their annual 100% acquisition of Hubdoc Inc in FY19. impairment test. Our audit procedures included the following: NZ IAS 36: Impairment of Assets requires that goodwill be tested for impairment annually irrespective of whether there is • Using our valuation specialists to: any indication of impairment and this assessment requires - assess whether the methodology applied in the value in judgement including consideration of both internal and use model met the requirements of NZ IAS 36; and external sources of information. - consider the discount rates and terminal growth rates The Group assesses goodwill impairment by using an internally used in the impairment models; developed value-in-use model which considers a range of scenarios. The range of scenarios considered by management • Considering the appropriateness of the changes made to in this assessment has changed in the period to specifically the cash generating units to which goodwill is allocated consider the potential impacts of the economic uncertainty across the Group; related to the COVID-19 pandemic. Key assumptions used in • Assessing the appropriateness of cash flow forecasts the value-in-use model are described in Note 10. considering historical cash flows, our knowledge of the During the reporting period management changed the cash business and relevant external information. Given the generation units to which this goodwill was allocated to reflect current economic uncertainty as a result of the COVID-19 a change in the way in which the Hubdoc technology is made pandemic, we placed a particular focus on the assumed available to customers. subscriber and associated revenue growth forecasts;
Disclosures relating to Goodwill, including key • Performing sensitivity analysis around key drivers of the assumptions, are included in Note 10 to the consolidated impairment model, including the sensitivity of the results financial statements. to changes in future projected cash flows; and
• Assessing whether the assumptions which have the most significant effect on the determination of the recoverable amount of goodwill have been appropriately disclosed in
the consolidated financial statements. For personal use only use personal For XERO LIMITED 35
Information other than the financial statements and Auditor’s responsibilities for the audit of the auditor’s report financial statements The directors of the company are responsible for the Annual Our objectives are to obtain reasonable assurance about Report, which includes information other than the whether the consolidated financial statements as a whole are consolidated financial statements and auditor’s report. free from material misstatement, whether due to fraud or error, and to issue an auditor’s report that includes our opinion. Our opinion on the consolidated financial statements does not Reasonable assurance is a high level of assurance, but is not a cover the other information and we do not express any form of guarantee that an audit conducted in accordance with assurance conclusion thereon. International Standards on Auditing (New Zealand) will always In connection with our audit of the consolidated financial detect a material misstatement when it exists. Misstatements statements, our responsibility is to read the other information can arise from fraud or error and are considered material if, and, in doing so, consider whether the other information is individually or in the aggregate, they could reasonably be materially inconsistent with the consolidated financial expected to influence the economic decisions of users taken statements or our knowledge obtained during the audit, or on the basis of these consolidated financial statements. otherwise appears to be materially misstated. A further description of the auditor’s responsibilities for the If, based upon the work we have performed, we conclude that audit of the financial statements is located at the External there is a material misstatement of this other information, we Reporting Board’s website: https://www.xrb.govt.nz/standards- are required to report that fact. We have nothing to report in for-assurance-practitioners/auditors-responsibilities/audit- this regard. report-1/. This description forms part of our auditor’s report.
Directors’ responsibilities for the financial statements The engagement partner on the audit resulting in this independent auditor’s report is Grant Taylor. The directors are responsible, on behalf of the entity, for the preparation and fair presentation of the consolidated financial statements in accordance with New Zealand equivalents to International Financial Reporting Standards and International Financial Reporting Standards, and for such internal control as Chartered Accountants the directors determine is necessary to enable the preparation Wellington of financial statements that are free from material 14 May 2020 misstatement, whether due to fraud or error.
In preparing the consolidated financial statements, the directors are responsible for assessing on behalf of the entity the Group’s ability to continue as a going concern, disclosing, as applicable, matters related to going concern and using the going concern basis of accounting unless the directors either intend to liquidate the Group or cease operations, or have no
realistic alternative but to do so. For personal use only use personal For 36 FINANCIAL STATEMENTS
Income Statement
2020 2019 Year ended 31 March Notes ($000s) ($000s)
Subscription revenue 696,220 538,384 Other operating revenue 22,011 14,435 Total operating revenue 4 718,231 552,819
Cost of revenue 5 (106,582) (90,915) Gross profit 611,649 461,904
Operating expenses Sales and marketing (312,852) (248,014) Product design and development (178,258) (137,795) General and administration (88,980) (66,072) Total operating expenses 5 (580,090) (451,881)
Asset impairments 9, 10 (1,427) (18,604) Other income and expenses 2,550 (96) Operating surplus/(deficit) 32,682 (8,677) Finance income 6 13,432 8,035 Finance expense 6 (36,277) (22,494) Net profit/(loss) before tax 9,837 (23,136) Income tax expense 19 (6,501) (4,007) Net profit/(loss) 3,336 (27,143)
Basic and diluted earnings/(loss) per share 7 $0.02 ($0.19)
Statement of Comprehensive Income
2020 2019 Year ended 31 March Note ($000s) ($000s)
Net profit/(loss) 3,336 (27,143)
Other comprehensive income* Movement in cash flow hedges (net of tax) 16 845 999 Translation of foreign operations (3,393) 1,006 Total other comprehensive income/(loss) for the period (2,548) 2,005 Total comprehensive income/(loss) for the period 788 (25,138)
For personal use only use personal For * Items of other comprehensive income will be reclassified to the Income Statement when specific conditions are met The accompanying notes form an integral part of these financial statements XERO LIMITED 37
Statement of Financial Position
At 31 March At 31 March 2020 2019 Notes ($000s) ($000s)
Assets Current assets Cash and cash equivalents 108,027 121,527 Short-term deposits 428,052 336,819 Trade and other receivables 8 55,877 49,466 Derivative assets 16 124,698 77,328 Other current assets 1,856 1,478 Total current assets 718,510 586,618
Non-current assets Property, plant and equipment 9 86,638 91,491 Intangible assets 10 342,246 289,731 Deferred tax assets 19 3,751 1,613 Derivative assets 16 – 238 Other non-current assets 2,543 627 Total non-current assets 435,178 383,700 Total assets 1,153,688 970,318
Liabilities Current liabilities Trade and other payables 11 42,954 27,043 Employee entitlements 39,893 37,830 Lease liabilities 13 11,755 11,541 Income tax payable 19 2,679 1,958 Derivative liabilities 16 3,157 147 Other current liabilities 12 15,694 26,560 Total current liabilities 116,132 105,079
Non-current liabilities Term debt 14 424,587 357,731 Derivative liabilities 16 121,972 77,367 Lease liabilities 13 60,871 71,308 Deferred tax liabilities 19 1,114 1,789 Other non-current liabilities 6,646 3,735 Total non-current liabilities 615,190 511,930 For personal use only use personal For Total liabilities 731,322 617,009
Equity Share capital 17 677,540 627,848 Reserves 85,362 69,333 Accumulated losses (340,536) (343,872) Total equity 422,366 353,309 Total liabilities and shareholders’ equity 1,153,688 970,318
The accompanying notes form an integral part of these financial statements 38 FINANCIAL STATEMENTS
Statement of Changes in Equity
Share- Foreign Premium based currency Cash flow on call Share Treasury payment Accumulated translation hedge spread Total capital shares reserve losses reserve reserve options equity Notes ($000s) ($000s) ($000s) ($000s) ($000s) ($000s) ($000s) ($000s)
Balance at 1 April 2019 638,234 (10,386) 30,902 (343,872) 904 2,266 35,261 353,309 Net profit – – – 3,336 – – – 3,336
Other comprehensive income/(loss) – – – – (3,393) 845 – (2,548)
Total comprehensive income – – – 3,336 (3,393) 845 – 788
Transactions with owners: Share-based payments 17, 22 16,282 585 23,497 – – – – 40,364
Exercising of employee and director share options 17, 22 17,353 – (4,920) – – – – 12,433 Issue of shares - deferred consideration for acquisition of Hubdoc 17 15,472 – – – – – – 15,472 Balance at 31 March 2020 687,341 (9,801) 49,479 (340,536) (2,489) 3,111 35,261 422,366
Balance at 1 April 2018 549,596 (11,852) 18,904 (316,729) (102) 1,267 – 241,084 Net loss – – – (27,143) – – – (27,143)
Other comprehensive income – – – – 1,006 999 – 2,005
Total comprehensive loss – – – (27,143) 1,006 999 – (25,138)
Transactions with owners: Share-based payments 17, 22 13,673 1,466 17,343 – – – – 32,482
Exercising of employee and director share options 17, 22 20,115 – (5,345) – – – – 14,770 Issue of shares - acquisition of Hubdoc, net of issuance costs 17 54,850 – – – – – – 54,850 Premium on call spread options, net of issuance
costs – – – – – – 35,261 35,261 For personal use only use personal For Balance at 31 March 2019 638,234 (10,386) 30,902 (343,872) 904 2,266 35,261 353,309
The accompanying notes form an integral part of these financial statements XERO LIMITED 39
Statement of Cash Flows
2020 2019 Year ended 31 March Note ($000s) ($000s)
Operating activities Receipts from customers 717,264 552,256 Other income 5,609 5,370 Interest received 14,363 5,028 Payments to suppliers and employees (542,760) (435,043) Interest paid (19,460) (9,502) Income tax paid (8,387) (3,883) Net cash flows from operating activities 20 166,629 114,226
Investing activities Capitalised development costs (111,296) (82,182) Acquisition of Hubdoc – (30,312) Capitalised contract acquisition costs (13,682) (13,512) Purchase of property, plant and equipment (13,872) (15,727) Other investing activities (674) 1,262 Net cash flows from investing activities (139,524) (140,471)
Financing activities Payment of lease liabilities (13,417) (9,103) Receipt of lease incentive 504 14,500 Exercising of share options 12,433 14,770 Proceeds from borrowings – 30,850 Repayment of borrowings – (31,583) Proceeds from issuance of convertible notes, net of issue costs – 447,766 Purchase of call spread options – (45,810) Payments for short-term deposits (785,753) (336,819) Proceeds from short-term deposits 734,563 59,000 Net cash flows from financing activities (51,670) 143,571 Net increase/(decrease) in cash and cash equivalents (24,565) 117,326 Foreign currency translation adjustment 11,065 (16,754) Cash and cash equivalents at the beginning of the period 121,527 20,955 Cash and cash equivalents at the end of the period 108,027 121,527
The accompanying notes form an integral part of these financial statements For personal use only use personal For 40 NOTES TO THE FINANCIAL STATEMENTS
Notes to the Financial Statements
1. REPORTING ENTITY AND STATUTORY BASE
Xero Limited (‘the Company’) is a company registered under the New Zealand Companies Act 1993 and is listed on the Australian Securities Exchange (ASX), and is required to be treated as an FMC Reporting Entity under the Financial Market Conducts Act 2013 and the Financial Reporting Act 2013.
The consolidated financial statements of the Group for the year ended 31 March 2020 were authorised in accordance with a resolution of directors for issue on 14 May 2020.
2. BASIS OF ACCOUNTING
(a) Basis of preparation
The audited consolidated financial statements of the Company and its subsidiaries (together 'the Group' or 'Xero') have been prepared in accordance with Generally Accepted Accounting Practice in New Zealand (NZ GAAP). The Group is a for-profit entity for the purposes of complying with NZ GAAP. The consolidated financial statements comply with New Zealand equivalents to International Financial Reporting Standards (NZ IFRS), other New Zealand accounting standards, and authoritative notices that are applicable to entities that apply NZ IFRS. The consolidated financial statements also comply with International Financial Reporting Standards.
Other than where described below, or in the notes, the consolidated financial statements have been prepared using the historical cost convention.
The consolidated financial statements are presented in New Zealand dollars ($) (the ‘presentation currency’). Items included in the financial statements of each of the Group’s entities are measured using the currency of the primary economic environment in which the entity operates (the ‘functional currency’).
(b) Changes in accounting policies and disclosures
The accounting policies and disclosures adopted are consistent with those of the previous year.
Certain comparative information has also been reclassified to conform with the current period’s presentation.
(c) Standards or interpretations issued but not yet effective and relevant to the Group
There are no standards or amendments that have been issued but are not yet effective that are expected to have a significant impact on the Group.
The Group has not adopted, and currently does not anticipate adopting, any standards prior to their effective dates.
(d) Critical accounting estimates
In applying the Group’s accounting policies, management continually evaluates judgements, estimates, and assumptions based on experience and other factors, including expectations of future events that may have an impact on the Group. All judgements, estimates, and assumptions made are believed to be reasonable based on the most current set of circumstances available to the
For personal use only use personal For Group. Actual results may differ from the judgements, estimates, and assumptions.
The significant judgements, estimates, and assumptions made by management in the preparation of these financial statements are outlined within the financial statement notes to which they relate. XERO LIMITED 41
3. SEGMENT INFORMATION
The Group operates in one business segment, providing online business solutions for small businesses and their advisors.
Xero has two operating segments: Australia and New Zealand (ANZ) and International. These segments have been determined based on how the Xero leadership team (the chief operating decision-maker) reviews financial performance.
Segment operating expenses represent sales and marketing costs and service delivery costs, including both in-country costs and an allocation of centrally managed costs.
ANZ International Total ($000s) ($000s) ($000s)
Year ended 31 March 2020 Operating revenue 436,530 281,701 718,231 Expenses (164,962) (254,472) (419,434) Segment contribution 271,568 27,229 298,797
Year ended 31 March 2019 Operating revenue 359,107 193,712 552,819 Expenses (140,175) (198,754) (338,929) Other income 69 331 400 Segment contribution 219,001 (4,711) 214,290
Reconciliation from segment contribution to net profit/(loss) before tax
2020 2019 Year ended 31 March ($000s) ($000s)
Segment contribution 298,797 214,290 Product design and development (178,258) (137,795) General and administration (88,980) (66,072) Asset impairments (1,427) (18,604) Other income and expenses 2,550 (496) Finance income 13,432 8,035 Finance expense (36,277) (22,494) Net profit/(loss) before tax 9,837 (23,136)
Depreciation and amortisation by segment
2020 2019 Year ended 31 March ($000s) ($000s)
ANZ 14,125 11,379
For personal use only use personal For International 18,799 14,542 Corporate (not allocated to a segment) 72,137 55,927 Total 105,061 81,848
At 31 March 2020, $361.2 million, or 84%, of the Group’s property, plant and equipment and intangible assets was domiciled in New Zealand (2019: $316.6 million, or 83%). 42 NOTES TO THE FINANCIAL STATEMENTS
Share-based payments by segment
2020 2019 Year ended 31 March ($000s) ($000s)
ANZ 7,601 5,600 International 8,110 8,325 Corporate (not allocated to a segment) 18,625 15,021 Total 34,336 28,946
4. REVENUE
Operating revenue by geographic location
2020 2019 Year ended 31 March ($000s) ($000s)
Australia 320,376 261,468 United Kingdom 183,565 119,521 New Zealand 116,154 97,639 North America 55,398 44,270 Rest of World 42,738 29,921 Total operating revenue 718,231 552,819
Subscription revenue
Subscription revenue comprises the recurring monthly fees from subscribers to Xero’s online software products. Subscribers are invoiced monthly. Unbilled revenue at year end is recognised in the Statement of Financial Position as accrued income and included within trade and other receivables. Unearned revenue at year end is recognised in the Statement of Financial Position as income in advance and included within other current liabilities.
Revenue is recognised as performance obligations under customer contracts are met. Performance obligations for subscriptions to Xero’s cloud-based software consist of the provisioning of the software and related support services over the term of the contract. Where the performance obligations of add-ons are usage-based (such as payroll and expenses), revenue is recognised consistent with the usage profile.
Other operating revenue
Other operating revenue comprises revenue from related non-subscription services like fintech products, along with income from conferences and events.
Performance obligations under fintech arrangements include the referral of customers to the revenue share counterparty and the continued servicing of that customer by the counterparty. Performance obligations for conference and event revenue consist of
the delivery of the conference or event. For personal use only use personal For XERO LIMITED 43
5. EXPENSES
Overhead allocation
The presentation of the Income Statement by function requires certain overhead costs to be allocated to functions. These allocations require management to apply judgement. Facilities, internal use information technology costs, and depreciation and amortisation not relating to external product software development have been allocated to functions on a headcount basis. Recruitment costs have been allocated according to the number of employees employed in each function during the period. The amortisation of product-related software development is included in product design and development.
Sales tax
The Income Statement and the Statement of Cash Flows have been prepared so that all components are stated exclusive of sales tax, except where sales tax is not recoverable. All items in the Statement of Financial Position are stated net of sales tax with the exception of receivables and payables, which include sales tax invoiced. Sales tax includes Goods and Services Tax and Value Added Tax where applicable.
Cost of revenue and operating expenses
2020 2019 Year ended 31 March ($000s) ($000s)
Employee entitlements 371,679 301,559 Employee entitlements capitalised (106,758) (82,200) Share-based payments 45,174 36,612 Share-based payments capitalised (10,838) (7,666) Advertising and marketing 113,227 76,421 Platform costs 40,252 33,468 Computer equipment and software 23,657 19,380 Consultants and contractors 18,936 18,506 Travel-related costs 16,356 11,601 Superannuation costs 15,094 11,373 Communication, insurance and office administration 7,962 6,820 Rental costs 5,768 3,487 Staff recruitment 3,523 2,166 Auditors’ remuneration 471 821 Other operating expenses 37,108 28,600 Total cost of revenue and operating expenses excl. depreciation and amortisation* 581,611 460,948
*Includes grant income of $5.2 million (2019: $5.2 million) For personal use only use personal For 44 NOTES TO THE FINANCIAL STATEMENTS
Depreciation and amortisation
2020 2019 Year ended 31 March ($000s) ($000s)
Relating to: Amortisation of development costs 69,452 53,600 Amortisation of other intangible assets 12,574 10,358 Depreciation of property, plant and equipment 23,035 17,890 Total depreciation and amortisation 105,061 81,848 Total cost of revenue and operating expenses 686,672 542,796
Depreciation and amortisation included in function expenses as follows: Product design and development 68,490 53,012 Cost of revenue 7,105 5,393 Sales and marketing 25,819 20,529 General and administration 3,647 2,914 Total depreciation and amortisation 105,061 81,848
Auditors’ remuneration
2020 2019 Year ended 31 March ($000s) ($000s)
Audit and review of financial statements 373 323 Other assurance services* 80 452 Taxation services 16 43 Other services** 2 3 Total fees paid to auditors 471 821
* Other assurance services relate to assurance services in connection with ISO 27001 certification and compliance services in respect of grant funding. Services in the comparative period also included assurance services in connection with reporting on service organisation controls, and comfort letter over convertible notes issuance. These additional independent assurance services were closely related to the financial statement audit
** Services relate to provision of remuneration market data
6. FINANCE INCOME AND EXPENSE
Finance income
Finance income comprises interest income on cash and cash equivalents and short-term deposits. Interest income is recognised as it is accrued using the effective interest method. The effective interest method calculates the amortised cost of the financial asset and allocates the interest income over its expected life.
Finance expense For personal use only use personal For
2020 2019 Year ended 31 March ($000s) ($000s)
Interest on convertible notes 28,033 12,753 Bank standby facility costs 1,691 1,847 Lease liability interest 6,280 4,987 Other finance expense 273 2,907 Total finance expense 36,277 22,494 XERO LIMITED 45
7. EARNINGS PER SHARE The Group presents basic and diluted earnings per share (EPS) data for its ordinary shares.
Basic EPS is calculated by dividing the net profit/(loss) attributable to ordinary shareholders of the Company by the weighted average number of ordinary shares on issue during the year, excluding shares held as treasury shares.
Diluted EPS is determined by adjusting the net profit/(loss) attributable to ordinary shareholders and the weighted average number of ordinary shares on issue for the effects of all potential dilution to ordinary shares, which comprise convertible notes, restricted shares, options, and restricted stock units (RSUs). Instruments are only treated as dilutive when their conversion to ordinary shares would decrease EPS or increase the loss per share.
2020 2019 Year ended 31 March (000s)* (000s)*
Net profit/(loss) after tax $3,336 ($27,143) Add back: foreign exchange revaluation on contingent consideration included in ordinary shares for basic calculation prior to the date of share issue, net of tax ($44) – Net profit/(loss) attributable to equity holders of the Group, used in calculating $3,292 ($27,143) basic and diluted EPS
Weighted average number of ordinary shares for basic EPS 140,922 139,204 Effect of dilution from: Share options 1,376 – Restricted shares 450 – Restricted stock units 404 – Weighted average number of ordinary shares adjusted for the effect of dilution 143,152 139,204
Basic earnings/(loss) per share $0.02 ($0.19) Diluted earnings/(loss) per share $0.02 ($0.19)
* Except for per share amounts
For the year ended 31 March 2020, 6,474,084 shares that would be issued on conversion of the convertible notes and 131,941 shares that would be on issue for the full year relating to the Hubdoc acquisition are excluded from the diluted weighted average number of shares because their effect would be anti-dilutive. The shares resulting from the notes and contingent consideration are anti-dilutive as a result of the corresponding adjustments that would be required to be made to net profit
attributable to ordinary shareholders. For personal use only use personal For 46 NOTES TO THE FINANCIAL STATEMENTS
8. TRADE AND OTHER RECEIVABLES
2020 2019 At 31 March ($000s) ($000s)
Accrued income 22,750 21,957 Prepayments 22,617 16,405 Trade receivables 7,614 7,064 Provision for doubtful debts (633) (504) Interest receivable 2,534 3,465 Rental bonds and other receivables 995 1,079 Total trade and other receivables 55,877 49,466
Trade and other receivables are initially recognised at the fair value of the amounts to be received, plus transaction costs (if any). They are subsequently measured at amortised cost (using the effective interest method) less impairment losses.
Trade receivables relate primarily to the monthly subscriptions to Xero’s online products. Subscriptions are charged monthly, the majority being paid by direct debit. At 31 March 2020, trade receivables of the Group of $876,000 were past due and are considered partially impaired (2019: $704,000). At 1 April 2018, accrued income was $19.1 million.
Key estimates and assumptions
In accordance with NZ IFRS 9: Financial Instruments, the Group recognises impairment losses using the lifetime Expected Credit Loss (ECL) model. ECLs are based on the difference between the contractual cash flows due in accordance with the contract and the cash flows that the Group expects to receive.
A six month historical default rate is applied to the current period trade receivables balance to calculate the impairment. At 31 March 2020, this default rate was increased to reflect the potential impact of the COVID-19 pandemic on credit losses. The carrying amount of the asset is reduced through the use of a provision account, and the amount of the loss is recognised in the Income Statement. When a receivable is uncollectible, it is written off against the provision account for receivables.
Subsequent recoveries of amounts previously written off are credited against the Income Statement. For personal use only use personal For XERO LIMITED 47
9. PROPERTY, PLANT AND EQUIPMENT
Right of use Leasehold Furniture and Computer asset improvements equipment equipment Total ($000s) ($000s) ($000s) ($000s) ($000s)
Year ended 31 March 2020 Opening net book value 63,440 15,474 7,542 5,035 91,491 Additions 8,312 4,866 4,478 4,770 22,426 Disposals* (6,795) (87) (366) (41) (7,289) Depreciation expense (12,614) (3,662) (2,355) (4,404) (23,035) Impairment reversals 207 – – – 207 Foreign exchange adjustment 2,257 152 279 150 2,838 Closing net book value 54,807 16,743 9,578 5,510 86,638
At 31 March 2020 Cost 79,552 23,836 15,374 11,602 130,364 Accumulated depreciation (24,745) (7,093) (5,796) (6,092) (43,726) Closing net book value 54,807 16,743 9,578 5,510 86,638
* $6.8m of right of use asset disposals relates to disposal of lease liabilities (2019: $1.9 million)
Right of use Leasehold Furniture and Computer asset improvements equipment equipment Total ($000s) ($000s) ($000s) ($000s) ($000s)
Year ended 31 March 2019 Opening net book value 42,419 10,271 5,687 3,427 61,804 Additions 33,520 8,351 3,828 4,669 50,368 Disposals (1,863) (1,047) – (9) (2,919) Depreciation expense (10,709) (2,077) (2,020) (3,084) (17,890) Impairments (497) – – – (497) Foreign exchange adjustment 570 (24) 47 32 625 Closing net book value 63,440 15,474 7,542 5,035 91,491
At 31 March 2019 Cost 86,764 20,706 13,052 8,890 129,412 Accumulated depreciation (23,324) (5,232) (5,510) (3,855) (37,921) Closing net book value 63,440 15,474 7,542 5,035 91,491
Key estimates and assumptions
Property, plant and equipment are stated at historical cost less depreciation. Depreciation on assets is charged on a straight-line basis to allocate the differences between their original cost and the residual
values over their estimated useful lives, as follows: For personal use only use personal For
Leasehold improvements Term of lease** Computer equipment 2 - 3 years Furniture and equipment 2 - 7 years Right of use asset* Term of lease**
* Substantially all of the right of use asset relates to building leases ** Lease terms range between 1 -12 years
The residual values and useful lives of assets are reviewed and adjusted if appropriate at each balance date. If an asset’s carrying amount is greater than its estimated recoverable amount, the carrying amount is immediately written down to its recoverable amount. 48 NOTES TO THE FINANCIAL STATEMENTS
10. INTANGIBLE ASSETS
Software Contract Other intangible development acquisition asset assets Goodwill Total ($000s) ($000s) ($000s) ($000s) ($000s)
Year ended 31 March 2020 Opening net book value 177,695 28,727 4,536 78,773 289,731 Additions* 120,542 13,829 345 – 134,716 Amortisation expense (69,452) (10,937) (1,637) – (82,026) Impairments (1,634) – – – (1,634) Foreign exchange adjustment – 1,459 – – 1,459 Closing net book value 227,151 33,078 3,244 78,773 342,246
At 31 March 2020 Cost 370,563 60,360 6,075 78,773 515,771 Accumulated amortisation (143,412) (27,282) (2,831) – (173,525) Closing net book value 227,151 33,078 3,244 78,773 342,246
* Included in software development additions is $17.3 million of externally purchased assets (2019: $14.5 million)
Software Contract Other intangible development acquisition asset assets Goodwill Total ($000s) ($000s) ($000s) ($000s) ($000s)
Year ended 31 March 2019 Opening net book value 139,146 24,035 470 5,165 168,816 Additions 89,583 13,384 – – 102,967 Acquisitions 15,508 – 5,270 78,773 99,551 Amortisation expense (53,600) (9,154) (1,204) – (63,958) Impairments (12,942) – – (5,165) (18,107) Foreign exchange adjustment – 462 – – 462 Closing net book value 177,695 28,727 4,536 78,773 289,731
At 31 March 2019 Cost 283,244 50,435 5,733 78,773 418,185 Accumulated amortisation (105,549) (21,708) (1,197) – (128,454) Closing net book value 177,695 28,727 4,536 78,773 289,731
Key estimates and assumptions
Software development Costs that are directly associated with the development of software are recognised as intangible assets where the following criteria are met:
– It is technically feasible to complete the software product so that it will be available for use For personal use only use personal For – Management intends to complete the software product and use or sell it – There is an ability to use or sell the software product – It can be demonstrated how the software product will generate probable future economic benefits – Adequate technical, financial, and other resources to complete the development and to use or sell the software product are available – The expenditure attributable to the software product during its development can be reliably measured XERO LIMITED 49
Other development expenditure that does not meet the above criteria is recognised as an expense when incurred. Development costs previously recognised as expenses are not recognised as assets in a subsequent period. Research costs, and costs associated with maintenance, are recognised as an expense when incurred.
At 31 March 2020, if software development capitalisation rates had been 10% higher/lower with all other variables held constant, the impact on operational expenses would have been $10.3 million lower/higher.
Contract acquisition asset In accordance with NZ IFRS 15: Revenue, Xero capitalises incremental costs of obtaining customer contracts. Capitalisable costs consist of sales commissions that have a direct relationship to new revenue contracts obtained. Costs capitalised are amortised to sales and marketing and expensed over the average period of benefit associated with the costs. The period of benefit for the contract acquisition asset is determined to be five years. Management have determined this as appropriate with reference to estimated customer lifespans and the useful lives of the software to which the commissions relate.
Other intangible assets Other intangible assets consist of patents, domains, and trademark costs, along with customer contracts. Other intangible assets acquired are initially measured at cost. Internally generated assets, excluding capitalised development costs, are not capitalised and expenditure is recognised in the Income Statement when the expenditure is incurred.
Useful lives of intangible assets With the exception of goodwill, the useful lives of the Group’s intangible assets are assessed to be finite. Assets with finite lives are amortised over their useful lives and tested for impairment whenever there are indications that the assets may be impaired.
Amortisation is recognised in the Income Statement on a straight-line basis over the estimated useful life of the intangible asset, from the date it is available for use. The estimated useful lives are as follows:
Software development 3 - 7.5 years Contract acquisition asset 5 years Customer contracts 3 years Patents, domains, and trademark costs 5 - 10 years
Impairment considerations At each reporting date, the Group assesses whether there is any indication that an asset may be impaired. Where an indicator of impairment exists, the Group makes a formal estimate of the recoverable amount. Where the carrying value of an asset exceeds its recoverable amount, the asset is considered impaired and is written down to its recoverable amount.
The recoverable amount is the greater of fair value less costs to sell or the asset’s value in use. For the purposes of assessing impairment, assets are grouped at the lowest levels for which there are separately identifiable cash flows.
The Group recognised impairment losses of $1.6 million during the year ended 31 March 2020 on write-down of software development (2019: $12.9 million).
Goodwill is tested at least annually for impairment, or whenever indicators of impairment exist.
An impairment loss is recorded against goodwill if its recoverable amount is less than its carrying amount. The recoverable amount is the higher of fair value less costs to sell and value in use. In assessing value in use, the estimated future cash flows are
discounted to their present value using a pre-tax discount rate. For personal use only use personal For
Goodwill and goodwill impairment testing Goodwill represents the excess of purchase consideration over the fair value of net assets acquired in a business combination. Goodwill is allocated to cash-generating units (CGUs), which are the lowest level of assets for which separately identifiable cash flows can be attributed. Xero’s goodwill at 31 March 2020 relates solely to the acquisition of Hubdoc Inc. and has been allocated to the ANZ and International CGUs. Of the $78.8 million of goodwill, $39.0 million is allocated to ANZ and $39.8 million is allocated to International. 50 NOTES TO THE FINANCIAL STATEMENTS
For the year ended 31 March 2019, the Hubdoc Inc. goodwill was allocated to the Hubdoc CGU. The reallocation of goodwill to new CGUs in the current year has arisen from the fact that the Hubdoc product from March 2020 was bundled with Xero’s core accounting software, therefore separately identifiable cash flows are no longer able to be attributed to the Hubdoc CGU.
The recoverable amount of the ANZ and International CGUs were calculated on the basis of value in use using a discounted cash flow model. Future cash flows were projected for five years for ANZ and ten years for International, with key assumptions being CGU earnings which is based on expected future performance of the CGUs. A period of ten years was used to project future cash flows for the International CGU due to the early stage of growth the market is in.
Key assumptions applied for the Group include growth rate of 7.0% (2019: 15.0%), pre-tax discount rate of 10.0% (2019: 20.0%), and terminal growth rate of 5.6% (2019: 3.0%). The terminal growth rate is determined based on the long-term anticipated growth rate of the business. The forecast financial information is based on both past experience and future expectations of CGU performance. Estimated potential future impacts of COVID-19 have been considered within forecast financial information. The major inputs and assumptions used in performing an impairment assessment that require judgement include revenue forecasts, operating cost projections, discount rates, terminal growth rates, and future technology paths.
No impairment arose as a result of goodwill impairment testing for the year ended 31 March 2020.
11. TRADE AND OTHER PAYABLES
2020 2019 At 31 March ($000s) ($000s)
Trade payables 10,615 5,690 Accrued expenses 23,440 15,434 Sales tax payable 8,899 5,919 Total trade and other payables 42,954 27,043
The Group recognises trade and other payables initially at fair value and subsequently at amortised cost using the effective interest method. The amounts are unsecured and non-interest bearing.
12. OTHER CURRENT LIABILITIES
2020 2019 At 31 March ($000s) ($000s)
Income in advance 9,607 7,682 Accrued interest 5,812 5,114 Other short-term liabilities 275 309 Contingent consideration – 13,455 Total other current liabilities 15,694 26,560
The Group recognises other current liabilities initially at fair value, and subsequently at amortised cost using the effective interest method.
Income in advance is recognised when the Group has received consideration prior to services being rendered. All income in
For personal use only use personal For advance from the prior period was subsequently recognised as revenue in the year. XERO LIMITED 51
13. LEASE LIABILITIES
2020 2019 ($000s) ($000s)
Balance at 1 April 82,849 45,437 Leases entered into during the period 5,988 33,267 Lease incentives received 504 14,500 Principal repayments (13,417) (9,103) Change in future lease payments (6,213) (1,889) Foreign exchange adjustment 2,915 637 Balance at 31 March 72,626 82,849
Current 11,755 11,541 Non-current 60,871 71,308
Under NZ IFRS 16: Leases the Group is required to recognise lease liabilities for contracts identified as containing a lease, except when the lease is for 12 months or less or the underlying asset is of low value.
Payments associated with short-term leases and leases of low-value assets are recognised on a straight-line basis as an expense in the Income Statement. Low-value assets comprise IT equipment and small items of office furniture. The expense relating to low-value assets for the year ended 31 March 2020 was $2.8 million (2019: $2.2 million).
Lease liabilities are initially measured at the present value of the remaining lease payments, discounted at the Group’s incremental borrowing rate. Subsequently, the carrying value of the liability is adjusted to reflect interest and lease payments made. Lease liabilities may be re-measured when there is a change in future lease payments arising from a change in an index or market rate, or if there is a change in the Group’s estimate of the amount expected to be payable.
Key estimates and assumptions
The Group assesses at lease commencement whether it expects to exercise renewal options included in contracts. Where it is reasonably certain that renewal options will be exercised, the extension period is included in the lease liability calculation.
14. TERM DEBT
Convertible notes
In September 2018, Xero Investments Limited, a wholly owned subsidiary of the Company, made an offering of USD300 million of convertible notes. The convertible notes were settled and listed on the Singapore Exchange Securities Trading Limited (SGX-ST) on 5 October 2018. The notes have a coupon interest rate of 2.375% per annum, payable six-monthly in arrears.
The notes are unsubordinated, unsecured obligations of Xero, and are scheduled to mature on 4 October 2023. The settlement of the notes will be in cash unless Xero elects to settle in shares, in which case Xero will be obliged to deliver ordinary shares to relevant noteholders. The cash settlement amount will be calculated based on the volume-weighted average price of the ordinary
shares over a 90 day trading period. For personal use only use personal For 52 NOTES TO THE FINANCIAL STATEMENTS
Notes and conversion feature derivative
The conversion feature of the notes is required to be separated from the notes and is accounted for as a derivative financial liability. The principal amount, unamortised debt discount, unamortised issuance costs, and net carrying amount of the liability component of the notes at 31 March are as follows:
2020 2019 At 31 March ($000s) ($000s)
Principal amount 500,526 440,787 Unamortised debt discount (69,473) (75,984) Unamortised issuance costs (6,466) (7,072) Term debt 424,587 357,731
The effective interest rate for the convertible notes is 7.30%. The coupon interest expense, and amortisation of debt discount and issuance costs for the year ended 31 March were as follows:
2020 2019 Year ended 31 March ($000s) ($000s)
Coupon interest expense 11,010 5,126 Amortisation of debt discount and issuance costs 17,023 7,627 Total finance expense on convertible notes 28,033 12,753
Call spread options
In connection with the issuance of the convertible notes, Xero purchased call spread options which are expected to reduce potential dilution to shareholders upon conversion of the notes and to offset any cash payments Xero may be required to make in excess of the principal amounts on conversion. The call spread options consist of 6.5 million lower strike call options purchased with an average strike price equal to the conversion price of the notes, and 6.5 million upper strike call options sold with an average strike price of USD60.5966. The call spread options expire on 4 October 2023.
The upper strike call options are accounted for as equity, and are recognised at their fair value, less transaction costs. On initial recognition, the upper strike options were recognised at a fair value of $35.3 million and were not subsequently revalued.
15. FINANCIAL INSTRUMENTS, CAPITAL AND FINANCIAL RISK MANAGEMENT
Financial instruments
Financial instruments recognised in the Statement of Financial Position include cash and cash equivalents, short-term deposits, receivables and payables, contingent consideration, term debt, and derivative financial instruments. The Group’s policy is that no speculative trading in financial instruments may be undertaken.
Classification and fair values
Xero has carried out a fair value assessment of its financial assets and liabilities at 31 March 2020 in accordance with NZ IFRS 9.
For personal use only use personal For Under NZ IFRS 9, financial instruments are classified as either measured at amortised cost, fair value through other comprehensive income, or fair value through profit or loss. The classification of the Group’s financial instruments into these categories is included within the table below.
The Group’s foreign exchange derivatives are recognised at fair value. Fair value is determined using forward exchange rates that are quoted in an active market (level two on the fair value hierarchy).
The fair values of the conversion feature and call option derivative asset relating to the convertible notes are determined using valuation techniques. These valuation techniques maximise the use of observable market data where it is available and rely as little as possible on entity-specific estimates (level two on the fair value hierarchy). Inputs into the valuation include share price volatility and time to expiration. XERO LIMITED 53
At initial recognition, the fair value of the convertible notes was determined using a market interest rate for an equivalent non-convertible bond. The notes are subsequently recognised at amortised cost. The fair value of the debt component of the convertible notes at 31 March 2020 was $454.5 million (2019: $362.6 million).
The carrying values of the Group’s other financial instruments do not materially differ from their fair value.
There were no transfers between classes of financial instruments during the period.
Financial instruments at fair Financial assets at value through profit Financial liabilities Total carrying amortised cost or loss at amortised cost value ($000s) ($000s) ($000s) ($000s)
At 31 March 2020 Assets Cash and cash equivalents 108,027 – – 108,027 Term deposits 428,052 – – 428,052 Trade and other receivables 11,837 – – 11,837 Derivative assets (foreign currency derivatives)* – 7,347 – 7,347 Derivative assets (call spread options) – 117,351 – 117,351 Total financial assets 547,916 124,698 – 672,614
Liabilities Trade and other payables – – 34,055 34,055 Derivative liabilities (foreign currency derivatives)* – 3,256 – 3,256 Derivative liabilities (conversion feature on convertible notes) – 121,873 – 121,873 Term debt – – 424,587 424,587 Other current liabilities – – 5,812 5,812 Other non-current liabilities – 2,840 – 2,840 Total financial liabilities – 127,969 464,454 592,423
At 31 March 2019 Assets Cash and cash equivalents 121,527 – – 121,527 Term deposits 336,819 – – 336,819 Trade and other receivables 11,731 – – 11,731 Derivative assets (foreign currency derivatives)* – 3,567 – 3,567 Derivative assets (call spread options) – 73,999 – 73,999 Total financial assets 470,077 77,566 – 547,643
Liabilities Trade and other payables – – 21,124 21,124 Derivative liabilities (foreign currency derivatives)* – 147 – 147
Derivative liabilities (conversion feature on convertible notes) – 77,367 – 77,367 For personal use only use personal For Term debt – – 357,731 357,731 Other current liabilities – 13,455 5,114 18,569 Other non-current liabilities – 600 – 600 Total financial liabilities – 91,569 383,969 475,538
* Foreign currency derivatives are hedge accounted when possible with unrealised gains and losses recognised in other comprehensive income until the underlying cashflows are realised, at which point the gains and losses are reclassified to the Income Statement 54 NOTES TO THE FINANCIAL STATEMENTS
Capital management
The capital structure of the Group primarily consists of equity raised by the issue of ordinary shares in the Company and issued debt.
Xero manages its capital to ensure that it maintains an appropriate capital structure to support its business and maximise shareholder value. The Group’s capital structure is adjusted based on business needs and economic conditions. During the year ended 31 March 2019, Xero issued USD300 million of convertible notes for the purpose of investments into strategic and complementary businesses and assets which are in line with the Group’s strategy to drive long-term shareholder value.
As part of the Group’s ongoing risk management, during the year ended 31 March 2020 the Group renewed its standby syndicated facility for a further three year term. As part of this, the facility was increased from $100 million to $150 million. Counterparties to the facility are ANZ, BNZ, HSBC, and Citibank.
The facility provides Xero with additional liquidity to cover unforeseen operating cash flow requirements. The facility agreement contains financial undertakings usual for facilities of this nature. The facility remains undrawn and there are no current plans to draw down on the facility.
Financial risk management
The Group is exposed to the following risks through the normal course of business and from its use of financial instruments:
a. Market risk b. Liquidity risk c. Credit risk
The following presents both qualitative and quantitative information on the Group’s exposure to each of the above risks, along with policies and processes for managing risk.
(a) Market risk
The Group is exposed to market risk primarily through changes in foreign currency exchange rates and interest rates.
Foreign currency risk
Nature of risk
Foreign currency risk is the risk that the New Zealand dollar (NZD) net cash flows that flow through to the Group are negatively impacted by changes to foreign currency exchange rates.
Exposure and risk management
Xero is exposed to currency risk from the operations of foreign subsidiaries and foreign currency denominated expenses in the parent Company. The Group has significant operations in four currencies, being Great British pounds (GBP), Australian dollars (AUD), United States dollars (USD), and Canadian dollars (CAD), with exposures to other currencies to a lesser degree. The material exposures are USD and CAD outflows, as well as AUD and GBP inflows. In order to reduce the impact of short-term movements in exchange rates, the Group’s treasury policy requires a portion of the next 18 months’ cash flows to be hedged with
forward exchange contracts and vanilla options (outright purchased options and vanilla collars). For personal use only use personal For XERO LIMITED 55
The Group’s exposure to monetary foreign currency financial instruments and lease liabilities is outlined below in NZD:
AUD USD GBP CAD ($000s) ($000s) ($000s) ($000s)
At 31 March 2020 Exposures Cash and cash equivalents, and short-term deposits 8,525 419,699 9,004 2,310 Trade and other receivables 1,387 3,695 2,736 174 Trade and other payables (8,766) (7,019) (6,187) (524) Other current liabilities – (5,812) – – Other non-current liabilities – – (2,840) – Lease liabilities (5,392) (13,523) (1,794) (1,223) Term debt (including conversion feature) – (500,526) – – Derivative financial instruments (foreign currency derivatives) 85,164 (31,517) 63,990 (13,231) Total foreign currency exposure 80,918 (135,003) 64,909 (12,494)
At 31 March 2019 Exposures Cash and cash equivalents, and short-term deposits 14,664 366,744 5,734 874 Trade and other receivables 914 635 1,928 207 Trade and other payables (2,649) (3,639) (4,787) (551) Other current liabilities – (18,569) – – Other non-current liabilities – – (600) – Lease liabilities (5,872) (19,557) (3,135) (102) Term debt (including conversion feature) – (440,788) – – Derivative financial instruments (foreign currency derivatives) 64,667 (65,804) 58,957 – Total foreign currency exposure 71,724 (180,978) 58,097 428
At 31 March, a movement of 10% in the NZD would impact the Income Statement and Statement of Changes in Equity (after hedging) as detailed in the table below:
10% decrease 10% increase 2020 2019 2020 2019 ($000s) ($000s) ($000s) ($000s)
Impact on: Net profit/(loss) before income tax (increase/(decrease)) (1,751) 905 1,432 (740) Equity (before income tax) (increase/(decrease)) 12,646 1,199 (10,214) 889
This analysis assumes a movement in the NZD across all currencies and only includes the effect of foreign exchange movements
on financial instruments. All other variables remain constant. For personal use only use personal For 56 NOTES TO THE FINANCIAL STATEMENTS
Interest rate risk Nature of risk
Interest rate risk is the risk that changes in interest rates negatively impact the Group’s financial performance or the value of its financial instruments.
Exposure and risk management
The Group’s interest rate risk arises from its cash and cash equivalents and short-term deposit balances, and when term debt at fixed rates is refinanced. Cash and cash equivalents comprise cash on hand, deposits held on at call with banks, funds invested in money market funds, and other short-term and highly liquid investments with original maturities of 90 days or less. Surplus balances are placed on short-term deposit at fixed rates. The repricing of these at maturity exposes the Group to interest rate risk. Money market funds invested into include a broad range of highly-rated short-term fixed income securities and calculate investment returns on a daily basis. Changes to interest rates will impact the returns generated by each fund. The convertible notes give rise to interest rate risk at maturity (October 2023) if the Group were to refinance at prevailing interest rates, with higher interest rates increasing the cost of debt financing should they be in effect at this time.
The Group does not currently enter into interest rate hedges. However, management regularly reviews its banking arrangements to ensure it achieves the best returns on its funds while maintaining access to necessary liquidity levels to service the Group’s day-to-day activities.
Sensitivity to interest rate risk
If interest rates for the year had been 1.0% higher/lower with all other variables held constant, the impact on the interest income, net profit and accumulated losses of the Group would have been $5.4 million lower/higher (2019: $4.6 million). This analysis assumes that the cash and cash equivalents and short-term deposits balance was consistent with the year end balance throughout the year.
(b) Liquidity risk
Nature of risk
Liquidity risk is the risk that the Group cannot pay contractual liabilities as they fall due.
Exposure and risk management
At 31 March 2020, the Group held cash and cash equivalents of $108.0 million and term deposits of $428.1 million. Of this, $43.4 million of cash and cash equivalents and $367.1 million of term deposits relates to the proceeds from the issuance of convertible notes, which is intended to be used for investments into strategic and complementary businesses and assets. The remaining $64.6 million of cash and cash equivalents and $61.0 million of term deposits is available to service the Group’s day-to-day activities. The $150 million syndicated standby facility provides additional liquidity to cover unforeseen operating cash flow requirements.
The liquidity risk that arises on maturity of the convertible notes in October 2023 is being closely monitored by management, with the intention that there will be repayment or refinancing plans in advance of this, to ensure that the Group has sufficient liquidity
to meet its contractual obligations as they fall due. For personal use only use personal For XERO LIMITED 57
The Group’s exposure to liquidity risk based on undiscounted contractual cash flows relating to financial liabilities and lease liabilities is summarised below: Total Less than Between 1 Between 2 Over contractual Carrying 12 months and 2 years and 5 years 5 years cash flows amount ($000s) ($000s) ($000s) ($000s) ($000s) ($000s)
At 31 March 2020 Non-derivative financial liabilities Trade and other payables 34,055 – – – 34,055 34,055 Lease liabilities 18,446 16,468 33,470 53,003 121,387 72,626 Term debt* 11,887 11,887 524,301 – 548,075 430,399 Other non-current liabilities – 2,840 – – 2,840 2,840 Contractual cash flows 64,388 31,195 557,771 53,003 706,357 539,920
Derivative financial liabilities Forward exchange contracts – – – – – (3,256) Inflows 62,563 3,095 – – 65,658 – Outflows (65,158) (3,128) – – (68,286) – Contractual cash flows (2,595) (33) – – (2,628) (3,256)
At 31 March 2019 Non-derivative financial liabilities Trade and other payables 21,124 – – – 21,124 21,124 Lease liabilities 17,819 17,009 30,849 53,200 118,877 82,849 Term debt* 10,349 10,469 472,193 – 493,011 362,845 Other current liabilities 13,455 – – – 13,455 13,455 Other non-current liabilities – 600 – – 600 600 Contractual cash flows 62,747 28,078 503,042 53,200 647,067 480,873
Derivative financial liabilities Forward exchange contracts – – – – – 147 Inflows 17,467 – – – 17,467 – Outflows (17,899) – – – (17,899) – Contractual cash flows (432) – – – (432) 147
* Term debt cash flows and carrying value include $5.8 million of interest included in other current liabilities at 31 March 2020 (2019: $5.1 million) For personal use only use personal For 58 NOTES TO THE FINANCIAL STATEMENTS
(c) Credit risk
Nature of risk
Credit risk arises in the normal course of Xero’s business on financial assets if a counterparty fails to meet its contractual obligations.
Exposure and risk management
Financial instruments that potentially subject the Group to credit risk principally consist of cash and cash equivalents, short-term deposits, derivatives, and receivables.
The Group manages credit risk by placing cash, short-term deposits, and derivative contracts with high quality financial institutions. The exposure to the credit risk of the call option counterparties means that in the event of default the Group may have to pay an increased amount on settlement of the convertible notes. The Group manages liquidity factoring in any risk of default. The credit risk associated with trade receivables is small due to the inherently low transaction value and the distribution over a large number of customers.
Group financial assets subject to credit risk at balance date are as follows:
2020 2019 At 31 March ($000s) ($000s)
Cash and cash equivalents 108,027 121,527 Short-term deposits 428,052 336,819 Trade and other receivables 10,510 11,104 Derivative financial assets 124,698 77,566 Non-current assets 1,327 627 Total financial assets subject to credit risk 672,614 547,643
A summary of the Group’s exposure to credit risk on cash and cash equivalents, short-term deposits, and derivatives categorised by external credit risk grading is as follows:
2020 2019 At 31 March ($000s) ($000s)
Cash and cash equivalents and short-term deposits A-1+ 470,121 406,612 A-1 60,379 47,533 A-2 5,579 4,201 Total cash and cash equivalents and short-term deposits 536,079 458,346 Derivative assets A-1+ 5,917 2,923 A-1 118,781 74,643 Total derivative assets 124,698 77,566 Total exposure to credit risk 660,777 535,912
The Group’s trade and other receivables and non-current assets are with counterparties who have no external credit risk rating. Due to the nature of the Group’s business, the balances do not consist of any concentration of risk that is considered individually For personal use only use personal For material. XERO LIMITED 59
16. DERIVATIVES AND HEDGE ACCOUNTING The Group’s derivative financial instruments consist of forward exchange contracts, vanilla foreign exchange options (outright purchased options and vanilla collars), conversion feature of the convertible notes, and call spread options entered into in connection with the convertible notes.
2020 2019 At 31 March ($000s) ($000s)
Current derivative assets Call spread options 117,351 73,999 Foreign exchange contracts 5,732 2,703 Foreign exchange options 1,615 626
Non-current derivative assets Forward exchange contracts – 189 Foreign exchange options – 49 Total derivative assets 124,698 77,566
Current derivative liabilities Forward exchange contracts (1,937) (89) Foreign exchange options (1,220) (58)
Non-current derivative liabilities Conversion feature of convertible notes (121,873) (77,367) Forward exchange contracts (39) – Foreign exchange options (60) – Total derivative liabilities (125,129) (77,514)
Foreign currency hedges
The Group uses derivatives in the form of forward exchange contracts and vanilla foreign exchange options (outright purchased options and vanilla collars) to reduce the risk that movements in foreign exchange rates will affect the Group’s NZD cash flows. Whenever possible, these hedges have been designated as a hedge of a highly probable forecast transaction (a cash flow hedge under NZ IFRS 9). The Group determines the existence of an economic relationship between the hedging instrument and the hedged item based on the currency and timing of respective cash flows. Derivatives in hedge relationships are designated based on a hedge ratio of 1:1. Hedges that do not have a highly probable forecast transaction are recognised as ineffective hedges. The Group’s policy is to hedge a portion of the next 18 months’ forecasted cash flows.
The effective portion of changes in the fair value of derivatives that are designated and qualify as cash flow hedges is recognised in other comprehensive income. The gain or loss relating to the ineffective portion is recognised immediately in the Income Statement. Amounts accumulated in equity are reclassified to the Income Statement in the periods when the hedged transaction affects profit and loss. Only the intrinsic value of options are designated as hedge relationships with movements in the time value of foreign exchange options recognised immediately in the Income Statement. The Group has taken up the option under NZ IFRS 9 to defer forward points into other comprehensive income.
For personal use only use personal For During the year, a net hedging gain of $6.8 million (before taxation) was recognised in other comprehensive income (2019: gain of $6.9 million). During the year, a gain of $5.6 million (before taxation) was reclassified out of other comprehensive income to the Income Statement (2019: gain of $5.5 million). The remaining balance will be reclassified to the Income Statement in the 18 months following 31 March 2020. 60 NOTES TO THE FINANCIAL STATEMENTS
Due to the uncertainty resulting from COVID-19, the Group revised its forecasted currency exposures, resulting in some hedge ineffectiveness. As a result of this ineffectiveness, a loss of $0.3 million was reclassified from other comprehensive income to the Income Statement. Amounts reclassified are recorded within other income and expenses. There was no other material ineffectiveness of hedging relationships.
Hedge position
The Group’s hedge accounted financial instruments are as follows:
2020 2020 2020 Notional 2019 2019 2019 Notional Average Fair amount hedged Average Fair amount hedged forward value (NZD) forward value (NZD) At 31 March rate ($000s) ($000s) rate ($000s) ($000s)
Derivative assets Buy USD - Sell NZD 0.6692 3,388 28,180 0.6898 553 53,641 Buy CAD - Sell NZD 0.8692 528 13,231 – – – Buy NZD - Sell AUD 0.9332 3,034 85,164 0.9214 2,262 58,957 Buy NZD - Sell GBP – – – 0.5083 730 46,400 Total 6,950 3,545
Derivative liabilities Buy USD - Sell NZD – – – 0.6723 (121) 12,162 Buy NZD - Sell AUD – – – 0.9633 (16) 5,710 Buy NZD - Sell GBP 0.5051 (2,643) 53,665 – – – Total (2,643) (137)
Conversion feature and call option derivative
The conversion feature derivative liability of the convertible notes represents an embedded derivative financial instrument in the host debt contract. The conversion feature represents the Group’s obligation to issue Xero Limited shares (or an equivalent amount of cash) should noteholders exercise their conversion option. The embedded conversion derivatives are carried in the Statement of Financial Position at their estimated fair value and adjusted at the end of each reporting period, with any unrealised gain or loss reflected in the Income Statement. During the period, the Group recognised a $33.6 million revaluation loss in the Income Statement relating to the conversion feature derivative (2019: $5.7 million gain).
In connection with the issue of the convertible notes, the Group entered into call spread options. The lower strike call options mirror the conversion option embedded in the convertible notes, and are accounted for as derivative assets in the Statement of Financial Position at their estimated fair value. The derivative assets are adjusted to fair value each reporting period, with unrealised gains or losses reflected in the Income Statement. During the year, the Group recognised a $32.9 million revaluation
gain in the Income Statement relating to the lower strike call options (2019: $5.0 million loss). For personal use only use personal For XERO LIMITED 61
17. SHARE CAPITAL
2020 2019 Note (000s) (000s)
Balance at 1 April 140,774 138,449 Issue of ordinary shares - acquisition of Hubdoc 176 1,133 Issue of ordinary shares - exercising of employee share options 22 504 748 Issue of ordinary shares - restricted stock unit schemes 22 266 180 Issue of ordinary shares - employee restricted share plan 22 67 228 Issue of ordinary shares - exercising of director and advisor share options 22 60 26 Issue of ordinary shares - directors’ fees 4 10 Ordinary shares on issue at 31 March 141,851 140,774 Treasury shares (339) (411) Ordinary shares on issue at 31 March excluding treasury shares 141,512 140,363
All shares have been issued, are fully paid, and have no par value.
During the year, the company issued 176,230 shares at a price of AUD84.85 for the settlement of the contingent consideration relating to the acquisition of Hubdoc.
During the year, employees exercised 504,021 share options with a weighted average exercise price of $22.70 (2019: 747,821, $19.20).
During the year, 327,917 RSUs vested, of which 266,190 were converted to shares with a weighted average price of $48.01. The remaining 61,727 were surrendered to settle payroll withholding obligations (2019: 249,608 vested, 179,554 converted at a weighted average price of $20.89, 70,504 surrendered to settle payroll withholding obligations).
During the year, the Company allocated 141,582 shares under the employee restricted share plan (RSP), at a weighted average price of AUD63.95 (2019: 364,955, AUD45.22). Of the shares allocated, 66,823 were new shares issued, and 74,759 were the reissue of shares held as treasury shares (2019: 228,459 and 136,496 respectively).
During the year, a director and an advisor exercised 59,530 share options, with a weighted average exercise price of $16.76 (2019: a director exercised 25,730 options with an exercise price of $16.14).
During the year, the Company issued 4,605 shares at a weighted average price of $59.65 to directors in lieu of cash payment for
directors’ fees (2019: 10,072, $40.17). For personal use only use personal For 62 NOTES TO THE FINANCIAL STATEMENTS
18. GROUP ENTITIES Consolidation subsidiaries are all entities over which the Group has control. The Group controls an entity when the Group is exposed to, or has rights to, variable returns from its involvement with the entity and has the ability to affect those returns through its power over the entity. Subsidiaries are fully consolidated from the date on which control is transferred to the Group. They are deconsolidated from the date that control ceases.
Inter-company transactions and balances between Group companies are eliminated on consolidation.
The financial statements of each of the Group’s subsidiaries are prepared in the functional currency of that entity. The functional currency is determined for each entity based on factors such as the principal trading currency. The assets and liabilities of these entities are translated at exchange rates existing at balance date. Revenue and expenses are translated at rates approximating the exchange rates ruling at the dates of the transactions. The exchange gains or losses arising on translation are recorded in other comprehensive income and accumulated in the foreign currency translation reserve in equity.
Interest Interest Principal activity Country of incorporation Balance date 2020 (%) 2019 (%)
Xero (NZ) Limited Reseller New Zealand 31 March 100 100 Xero (UK) Limited Reseller United Kingdom 31 March 100 100 Xero Australia Pty Limited Reseller Australia 31 March 100 100 Xero, Inc. Reseller United States 31 March 100 100 Xero (Singapore) Pte. Ltd Service provider Singapore 31 March 100 100 Xero Software (Canada) Ltd Service provider Canada 31 March 100 100 Xero (HK) Limited Service provider Hong Kong 31 March 100 100 Xero South Africa (Pty) Ltd Service provider South Africa 31 March 100 100 Xero Trustee Limited Trustee New Zealand 31 March 100 100 Hubdoc Inc. Reseller Canada 31 March 100 100 Hubdoc Pty Limited Reseller Australia 31 March 100 100 Hubdoc (UK) Limited Reseller United Kingdom 31 January 100 100 Xero Investments Limited Funding & investment New Zealand 31 March 100 100
Cicerone Limited Non-active United Kingdom 31 August 100 100 For personal use only use personal For XERO LIMITED 63
19. CURRENT AND DEFERRED INCOME TAX Tax expense comprises current and deferred tax. Income tax is recognised in the Income Statement or Statement of Comprehensive Income except when it relates to items recognised directly in equity (in which case the income tax is recognised in equity). Income tax is based on tax rates and regulations enacted in the jurisdictions in which the entities operate.
Deferred tax is recognised in respect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for taxation purposes. The amount of deferred tax is based on the expected manner of realisation of the carrying amount of assets and liabilities, using tax rates enacted or substantially enacted at the end of the reporting period.
A deferred tax asset is recognised only to the extent that it is probable that future taxable profits will be available against which the asset can be utilised.
Income tax expense
The tax on the Group’s profit/(loss) before tax differs from the theoretical amount that would arise using the New Zealand statutory income tax rate as follows:
2020 2019 Year ended 31 March ($000s) ($000s)
Accounting profit/(loss) before income tax 9,837 (23,136) At the New Zealand statutory income tax rate of 28% 2,754 (6,478) Non-deductible expenditure 370 1,640 Prior period adjustment (116) 119 Utilisation of tax losses not previously recognised (14,036) (10,074) Net research and development expense deferred 7,803 4,023 Tax rate variance of subsidiaries 847 2,890 Losses not recognised in current year 8,879 11,887 Income tax expense 6,501 4,007
Comprising: Income tax payable 9,196 5,361 Prior period adjustment (116) 119 Deferred tax (1,565) (1,153) Tax losses utilised (972) (398) Effect of changes in foreign currency (42) 78 Income tax expense 6,501 4,007
Income tax payable
2020 2019 ($000s) ($000s)
For personal use only use personal For Balance at 1 April 1,958 537 Prior period adjustment (83) 177 Income tax liability for the year 9,196 5,361 Income tax paid (8,387) (3,883) Effects of changes in foreign currency (5) (234) Income tax payable 2,679 1,958 64 NOTES TO THE FINANCIAL STATEMENTS
Deferred income tax
Provisions and Derivatives employee benefits Tax depreciation Tax losses Total ($000s) ($000s) ($000s) ($000s) ($000s)
Year ended 31 March 2020 Deferred tax asset balances At 1 April 2019 – 5,661 (2,849) (1,199) 1,613 Prior period adjustment – (547) 584 647 684 Charged to Income Statement – 4,153 (547) (2,718) 888 Charged to equity – (23) – 591 568 Impact of change in tax rates – 44 (46) – (2) At 31 March 2020 – 9,288 (2,858) (2,679) 3,751
Deferred tax liability balances At 1 April 2019 (881) 9,276 (19,048) 8,864 (1,789) Prior period adjustment – (267) 39 (412) (640) Charged to Income Statement – 2,185 (3,968) 2,462 679 Charged to equity (328) 3,452 – (3,460) (336) Tax losses utilised – – – 972 972 At 31 March 2020 (1,209) 14,646 (22,977) 8,426 (1,114)
Year ended 31 March 2019 Deferred tax asset balances At 1 April 2018 – 1,629 (1,129) – 500 Prior period adjustment – 42 (48) 21 15 Charged to Income Statement – 3,273 (1,672) (503) 1,098 Charged to equity – 717 – (717) – At 31 March 2019 – 5,661 (2,849) (1,199) 1,613
Deferred tax liability balances At 1 April 2018 (483) 6,603 (17,041) 10,308 (613) Prior period adjustment – (5) (409) 322 (92) Charged to Income Statement – 671 (268) (390) 13 Charged to equity (398) 2,053 – (1,774) (119) Tax losses utilised – – – 398 398 Impact of change in tax rates – (46) 88 – 42 Recognition of deferred tax on business combination – – (1,418) – (1,418)
At 31 March 2019 (881) 9,276 (19,048) 8,864 (1,789) For personal use only use personal For XERO LIMITED 65
Recognised temporary differences
The Group’s recognised deferred tax asset and deferred tax liability are expected to be recovered by $2.36 million and $0.48 million respectively within the next 12 months. Deferred tax assets and liabilities have been offset where the balances are due to/receivable from the same counterparties. Deferred income tax assets are recognised for carried forward tax losses to the extent of deferred tax liabilities.
Unrecognised temporary differences
The Group has elected to defer the deduction of research and development expenditure in accordance with sections DB 34(7) and EE 1(5) of the Income Tax Act 2007.
The total amount of deferred research and development expenditure available to the Group is $85.4 million (2019: $58.6 million). The deferred research and development expenditure can be deducted from taxable income in future periods, and the ability to carry forward deferred research and development expenditure is not dependent on maintaining shareholder continuity.
The Group has estimated unrecognised tax losses available to carry forward of $279.9 million (2019: $296.9 million) subject to shareholder continuity being maintained.
Key estimates and assumptions
The Group recognises a deferred tax asset in relation to tax losses to the extent of the Group’s deferred tax liabilities. Where it is probable that future taxable profit will be available against which carried forward tax losses can be utilised, a deferred tax asset will be recognised for these amounts, subject to shareholder continuity (or other legislative requirements). No material deferred tax asset has been recognised for losses in the Group, given the uncertainty of the timing of future profitability and the requirement for shareholder continuity.
20. RECONCILIATION OF OPERATING CASH FLOWS
2020 2019 Year ended 31 March ($000s) ($000s)
Net profit/(loss) 3,336 (27,143)
Adjustments: Depreciation 23,035 17,890 Amortisation 82,026 63,958 Share-based payments 34,336 28,946 Amortisation of debt discount and issuance costs 17,023 7,627 Impairment of assets 1,427 18,604 Deferred tax (1,565) (1,153) Tax losses utilised (972) (398) Bad debts 1,974 1,459 Other non-cash items (2,435) 766
Changes in working capital:
For personal use only use personal For Increase in trade receivables and prepayments (5,833) (14,111) (Increase)/decrease in interest receivable 931 (3,008) Increase in trade payables and other related items 6,396 5,068 Increase in income tax payable 721 1,421 Increase in employee entitlements 4,304 10,764 Increase in income in advance 1,925 3,536 Net cash flows from operating activities 166,629 114,226 66 NOTES TO THE FINANCIAL STATEMENTS
21. CHANGES IN FINANCIAL ASSETS AND LIABILITIES ARISING FROM FINANCING ACTIVITIES
Foreign Other At 1 April Amortisation exchange non-cash At 31 March 2019 Proceeds Payments expense movement items 2020 Year ended 31 March 2020 ($000s) ($000s) ($000s) ($000s) ($000s) ($000s) ($000s)
Short-term deposits 336,819 (734,563) 785,753 – 40,043 – 428,052 Term debt (357,731) – – (17,023) (49,833) – (424,587)
Foreign Other At 1 April Amortisation exchange non-cash At 31 March 2018 Proceeds Payments expense movement items 2019 Year ended 31 March 2019 ($000s) ($000s) ($000s) ($000s) ($000s) ($000s) ($000s)
Short-term deposits 59,000 (59,000) 349,459 – (12,640) – 336,819 Other current liabilities (733) – 733 – – – – Bank loans – (30,850) 30,850 – – – – Term debt* – (455,721) 7,955 (7,627) 12,197 85,465 (357,731)
* Other non-cash movements reflects the fair value of the embedded conversion derivative at inception of the debt
22. SHARE-BASED PAYMENTS The Group operates equity-settled, share-based compensation plans, under which employees provide services in exchange for non-transferable options, RSUs, or restricted shares. The value of the employee services rendered for the grant of non- transferable options, RSUs, and restricted shares is recognised as an expense over the vesting period, and the amount is determined by reference to the fair value of the options, RSUs, and restricted shares granted.
Employee restricted share plan
Under the employee restricted share plan, ordinary shares in the Company are issued to a trustee, Xero Limited Employee Restricted Share Trust, a wholly owned subsidiary, and allocated to participants on grant date, using funds lent to them by the Company.
The shares are beneficially owned by the participants. The length of retention period before the shares vest is up to three years. If the individual is still employed by the Group at the end of each specific period, the employee is given a bonus that must be used to repay the loan and shares are then transferred to the employee. The weighted average grant date fair value of restricted shares issued during the year was AUD63.95 (2019: AUD45.22) and was determined by the volume-weighted average price of the Company shares for the 20 trading days preceding the grant date. Shares with a grant date fair value of $11.1 million vested during
the year (2019: $12.7 million). The Group has no legal or constructive obligation to repurchase or settle the shares for cash. For personal use only use personal For XERO LIMITED 67
2020 2019 Number Number of shares of shares (000s) (000s)
Outstanding restricted shares at 1 April 371 522 Granted 142 365 Forfeited (61) (90) Settled (139) (426) Outstanding restricted shares at 31 March - allocated to employees 313 371 Forfeited shares not yet reallocated - held by Trustee 26 40 Total 339 411 Percentage of total ordinary shares 0.2% 0.3%
Ageing of unvested shares Vest within one year 138 261 Vest after one year 44 110 Total unvested shares at 31 March* 182 371
* Varies to outstanding restricted shares above as shares which vested on 31 March 2020 were not settled until 1 April 2020
The number of shares awarded pursuant to the RSP does not equal the number of shares created for the scheme as forfeited shares are held in the trust and reissued.
Share options scheme
Options are granted to selected employees, directors, and advisors. Options are conditional on the completion of the necessary years of service (the vesting period) as appropriate to that tranche.
The options’ tranches vest within four years from the grant date. No options can be exercised later than the second anniversary of the final vesting date. There were 52 holders of options at 31 March 2020 (2019: 44).
The Group has no legal or constructive obligation to repurchase or settle the options in cash.
Movements in the number of options outstanding and their related weighted average exercise prices are as follows:
2020 2019 Weighted average 2020 Weighted average 2019 exercise price Options exercise price Options ($) (000s) ($) (000s)
Outstanding at 1 April 31.91 2,995 20.65 2,225 Granted 64.85 763 39.13 2,092 Forfeited/expired 37.12 (333) 31.48 (548) Exercised 22.07 (564) 19.10 (774) Outstanding at 31 March 42.04 2,861 31.91 2,995 Exercisable at 31 March 21.32 288 19.55 365
For personal use only use personal For The weighted average share price on date of exercise for options exercised in the year ended 31 March 2020 was AUD67.94 (2019: AUD43.31). The weighted average remaining contractual term of options outstanding at 31 March 2020 is 3.1 years (2019: 3.6 years). 68 NOTES TO THE FINANCIAL STATEMENTS
Options outstanding at 31 March fall within the following ranges:
2020 2019 Options Options Granted Exercise price (000s) (000s)
2015-16 NZD16.00 – 30 2016-17 NZD17.51 - NZD19.50 445 830 2017-18 NZD25.75 - NZD32.48 190 327 2018-19 AUD34.00 - AUD48.33 1,463 1,808 2019-20 AUD51.82 - AUD83.04 763 – 2,861 2,995
The weighted average fair value of options granted during the year, determined using the Black-Scholes valuation model, was $18.89 per option (2019: $21.41).
The significant inputs into the model were the market share price at grant date, the exercise price as shown above, expected annualised volatility of between 31% and 36%, a dividend yield of 0%, an expected option life of between three and five years, and an annual risk-free interest rate of between 0.7% and 1.4%.
The volatility input is measured as the standard deviation of continuously compounded share returns and is based on a statistical analysis of daily share prices over a period consistent with the options’ expected life.
Restricted stock units
RSUs are issued to certain employees and executives of the Group. On the grant date, an RSU agreement is entered into between employee and Company stipulating the number of units granted and their vesting schedules. On the vest date, the RSUs are converted to ordinary shares in the Company.
No cash consideration is required to be paid on vesting of the RSUs. The fair value of RSUs granted in the year ended 31 March 2020 was $28.1 million (2019: $12.8 million) as determined by the volume-weighted average share price. The RSUs are conditional on the employees completing up to three years’ service (the vesting period) and are, for the most part, converted to shares in equal amounts over the vesting period.
2020 2019 Weighted average 2020 Weighted average 2019 grant date fair value RSUs grant date fair value RSUs ($) (000s) ($) (000s)
Outstanding at 1 April 38.89 370 21.64 401 Granted 66.00 425 46.23 277 Forfeited 53.71 (89) 32.05 (57) Converted to shares 48.01 (266) 20.93 (180) Surrendered to settle payroll withholding obligations 34.33 (61) 20.76 (71) Outstanding at 31 March 60.16 379 38.89 370
The Company withholds shares under certain circumstances to settle tax withholding obligations on vesting. Based on the market share price on 31 March 2020, future cash payments to meet tax withholding obligations on the vesting of RSUs are expected to For personal use only use personal For be $1.5 million (2019: $4.9 million). XERO LIMITED 69
23. KEY MANAGEMENT PERSONNEL AND RELATED PARTIES
Key management personnel
Key management personnel are defined as those persons having authority and responsibility for planning, directing, and controlling the activities of the Group, directly or indirectly, and include the directors, the Chief Executive, and his direct reports.
The following table summarises remuneration paid to key management personnel.
2020 2019 Year ended 31 March ($000s) ($000s)
Short-term employee benefits 8,329 7,807 Directors’ fees 1,332 1,214 Share-based payments - options 7,807 5,841 Share-based payments - restricted stock units 1,360 2,008 Share-based payments - employee restricted share plan 147 889
Related party transactions
During the year Atomic.io Limited, a related party, provided product development services to the Group of $0.2m.
A number of key management personnel, or their related parties, hold positions in other entities that result in them having control or significant influence over the financial or operating policies of these entities. A number of these entities subscribe to services provided by the Group. None of these related party transactions are significant to either party, and are completed on arm’s length terms. There were no other related party transactions during the year.
No amounts with any related parties have been written off or foregone during the year (2019: nil).
24. COMMITMENTS AND CONTINGENCIES
Capital commitments
Capital commitments of $1.2 million for building fit-outs were contracted for at 31 March 2020 but not yet incurred (2019: $1.0 million).
Contingent liabilities
There were no contingent liabilities at 31 March 2020 (2019: nil).
25. EVENTS AFTER THE BALANCE SHEET DATE
In March 2020, the World Health Organisation declared the outbreak of a novel coronavirus (COVID-19) as a pandemic. Subsequent to 31 March 2020, the virus continues to spread globally, giving rise to economic uncertainties which may impact Xero’s customers.
While the ultimate disruption which may be caused by the outbreak is uncertain, it may result in an adverse impact on the
Group’s financial position, performance, and cash flows, should it result in global economic downturn impacting our subscribers. For personal use only use personal For The related financial impact and duration cannot be reasonably estimated at this time.
There were no other significant events between balance date and the date these financial statements were authorised for issue. 70 DIRECTORS' RESPONSIBILITIES STATEMENT
Directors’ Responsibilities Statement
The directors are required to prepare financial statements for each financial year that present fairly the financial position of the Group and its operations and cash flows for that period.
The directors consider these financial statements have been prepared using accounting policies suitable to the Group’s circumstances, that these have been consistently applied and are supported by reasonable judgements and estimates, and that all relevant financial reporting and accounting standards have been followed.
The directors are responsible for keeping proper accounting records that disclose with reasonable accuracy, at any time, the financial position of the Group and to enable them to ensure that the financial statements comply with the Companies Act 1993 (New Zealand). They are also responsible for safeguarding the assets of the Group and for taking reasonable steps for the prevention and detection of fraud and other irregularities.
During the year ended 31 March 2020, the principal activities of the Group were for the provision of an online business platform to small businesses and their advisors. Other than as disclosed in this Annual Report, there were no significant changes in the state of affairs or activities of the Group during the year.
The Board authorised these financial statements for issue on 14 May 2020.
For and on behalf of the Board
David Thodey Lee Hatton Chair Director Xero Limited Xero Limited
14 May 2020 14 May 2020 For personal use only use personal For XERO LIMITED 71
Corporate Governance Statement
Xero is committed to high standards of corporate governance. ASX Corporate Governance Principles and Recommendations We believe this is essential for the long-term performance and (ASX Principles and Recommendations). This Corporate sustainability of Xero and supports the interests of our Governance Statement (Statement) addresses the shareholders. The Xero Board of Directors (the Board) is recommendations contained in the 3rd edition of the ASX responsible for ensuring that Xero has an appropriate Principles and Recommendations, which applies to Xero for corporate governance framework to protect and enhance the financial year ended 31 March 2020. For completeness, Xero’s performance and to build sustainable value. Xero’s we note that the 4th edition of the ASX Principles and corporate governance framework is designed to support our Recommendations will apply to Xero for the financial year business operations, deliver on our strategy, monitor ending 31 March 2021. This Statement is current as at 3 April performance, and manage risk. 2020, and has been approved by the Board.
Xero is listed on the Australian Securities Exchange (ASX) and The Statement should be read in conjunction with this is a New Zealand incorporated and domiciled company. From a Annual Report and Xero's Investor Centre at regulatory perspective, this means that while the ASX Listing www.xero.com/au/about/investors/governance, where Rules apply to Xero, certain provisions of the Australian full copies of Xero’s corporate governance policies and Corporations Act 2001 (Cth) do not.1 charters can be found.
Xero’s corporate governance reporting framework has been References to FY20 are to the year ended 31 March 2020. developed with regard to the ASX Listing Rules and the
For personal use only use personal For
1 Xero complies with the ASX Listing Rules. As Xero is not incorporated in Australia, it is not a disclosing entity for the purpose of Chapter 2M of the Australian Corporations Act 2001 (Cth) (Financial reports and audits) and certain provisions of that chapter do not apply (e.g. section 295 regarding annual financial report, section 298 regarding directors' report or section 300A regarding remuneration reporting). As a New Zealand company, Xero’s annual reporting is primarily governed by the Companies Act 1993 (New Zealand) 72 CORPORATE GOVERNANCE STATEMENT
ASX Principles and Recommendations
PRINCIPLE 1: LAY SOLID FOUNDATIONS FOR MANAGEMENT AND OVERSIGHT
The Board
Charter The Board Charter outlines the Board’s roles and The Board monitors Xero’s management and performance and responsibilities and describes those matters expressly ensures that management’s activities are aligned with the reserved for the Board’s determination and those matters expectations and risks identified by the Board and delegated to management. The Charter is available on management. The Board has a number of mechanisms to Xero’s website. ensure this is achieved, including:
The Board is appointed by the shareholders (other than - Approving Xero’s strategic plan, overseeing performance to directors who are appointed by the Board to fill a casual ensure alignment with the strategic plan, and focusing vacancy, who must be subsequently approved by shareholders Xero’s activities on long-term shareholder value at the next general meeting of the company), and meets - Assessing and making determinations on Xero’s culture sufficiently regularly to perform its role effectively. It comprises and management framework, governance policies, directors who bring a mix of skills, knowledge, experience, procedures and compliance, and relevant Board and diversity and independence, together with a deep Committee frameworks understanding of, and competence to deal with, current and emerging issues and to guide the business. - Approving Xero’s financial statements, required reports and annual budget, as well as confirming Xero’s financial Responsibilities The Board is responsible for overseeing position and overseeing and reviewing the integrity of and appraising Xero’s strategic direction, purpose, values, Xero’s accounting and corporate reporting systems policies, performance, risk appetite and governance framework. To assist with carrying out its responsibilities, the - Selecting the CEO, overseeing succession plans for Xero’s Board has established the following standing Committees: leadership team, and approving policies, practices and measurable objectives for achieving diversity 1. Audit and Risk Management Committee (ARM Committee) - Approving the remuneration framework, ensuring Xero’s remuneration policies and practices fit with its strategic 2. People and Remuneration Committee goals, and overseeing equity incentive programs (P&R Committee) - Approving an annual operating plan and systems of 3. Nominations Committee financial and non-financial risk management, as well The Board may also delegate specific functions to ad hoc as confirming Xero has in place accurate and reliable Committees from time to time. reporting systems, internal controls, compliance activities, and systems to monitor the effectiveness of Xero’s risk Xero’s Chief Executive Officer (CEO) has responsibility for the management framework day-to-day management and administration of the Xero business, supported by the rest of Xero’s leadership team. Appointment Before appointing a director, Xero undertakes The CEO manages Xero in accordance with the strategic plan, appropriate background checks to determine that annual budget, risk appetite, and risk management strategies candidate’s suitability.
approved by the Board. For personal use only use personal For XERO LIMITED 73
Board and Committee membership and meeting attendance The members of Xero’s Board and each of Xero’s Committees for FY20, and the number of scheduled1 meetings and attendance at those meetings was:
Director Board Nominations ARM P&R Committee Committee Committee
Held� Attended Held2 Attended Held2 Attended Held2 Attended David Thodey3 5 4 3* 3 - - 3 3 Rod Drury 7 7 ------Lee Hatton 7 6 - - 6* 6 - - Dale Murray4 7 7 - - 6 6 - - Susan Peterson5 7 7 - - - - 5* 5 Bill Veghte6 4 1 2 1 - - 3 1 Graham Smith7 7 7 4 4 6 6 - - Craig Winkler 7 7 4 4 - - 5 5
1 In addition to meetings scheduled in advance for the year, the Board and Committees hold other meetings as appropriate to meet governance demands. In FY20, the Board held three additional meetings, the Nominations Committee held seven additional meetings, the ARM Committee held one additional meeting and the P&R Committee held one additional meeting 2 Held represents the number of scheduled meetings held that the relevant director was eligible to attend 3 Appointed as a director 27 June 2019; appointed as Chair of the Board 1 February 2020; appointed as Chair of the Nominations Committee 26 February 2020 4 Appointed to the Nominations Committee 26 February 2020 5 Appointed as Chair of the P&R Committee 1 July 2019; appointed to the Nominations Committee 26 February 2020 6 Resigned as Chair of the P&R Committee effective 1 July 2019; resigned as a director effective 15 August 2019 7 Resigned as Chair of the Board effective 31 January 2020; resigned as Chair and member of the Nominations Committee effective 26 February 2020; resigned as a director effective 31 March 2020 * Committee Chair
The qualifications of each director are detailed on pages 13 and Company Secretary Chaman Sidhu is the Chief Legal Officer & 14 of this Annual Report. Company Secretary of Xero. Her qualifications and experience are set out on Xero’s website. All directors and members of Xero’s leadership team are appointed pursuant to formal letters of appointment or The Company Secretary is accountable to the Board, through agreements setting out the key terms and conditions of their the Chair, on all matters to do with the effective functioning of appointment, including remuneration. Director appointment the Board. The formal reporting line of the Company Secretary letters also include details regarding: Board, Committee and is through the CEO. All directors have direct access to the directors’ duties and responsibilities, time commitment, Board Company Secretary. and individual performance evaluation, disclosure of interests and matters affecting independence, confidentiality, the Board’s policy on obtaining independent advice, insurance, and
deeds of indemnity. For personal use only use personal For 74 CORPORATE GOVERNANCE STATEMENT
Diversity and inclusion
Xero values diversity and inclusion and considers it a priority in Respect and Responsibility Policy Xero’s Respect and the creation of a sustainable business capable of delivering Responsibility Policy supports a clear and consistent approach shareholder value. Xero embraces the diverse experience, to equal opportunity, promotes a workplace free from ideas, skills and perspectives of our people. Having a diverse discrimination, harassment, sexual harassment, and bullying, workforce enables Xero to innovate, attract and retain top and sets out the internal process to resolve concerns and talent, and to better reflect and serve our customers, partners, complaints. The policy is supported by an online training and the communities we interact with every day. Xero takes a module for all employees and additional face-to-face training broad view of the meaning of diversity and believes that it’s for people managers. through inclusion that we will tap into the potential and power Wellbeing At Xero, we value wellbeing and believe it is part of of our people’s differences. our commitment to create an inclusive work environment to Diversity and Inclusion Policy Xero’s Diversity and Inclusion support our employees, customers and partners. Internally, we Policy outlines requirements for the Board to establish have delivered a range of wellbeing activities including mental measurable objectives for achieving diversity and to annually health training, resilience workshops, mindfulness programs assess those objectives and the progress towards achieving and initiatives to promote physical health and financial them. This policy is available on Xero’s website. wellbeing. In FY20, we also completed a strategic review of our wellbeing initiatives as the first step in developing a global The policy reflects six key principles that provide the strategy to consolidate and enhance our efforts in this area. framework for Xero’s goal of developing and maintaining a diverse and inclusive workplace and the implementation of initiatives to support this. The key principles are:
1. We value diversity because it reflects and serves our customers and ensures our people thrive
2. We’re all accountable to create an inclusive culture
3. We’re committed to attracting diverse talent and hiring fairly
4. We support flexible ways of working
5. We’re committed to equal pay for equal work
6. We have an obligation to champion diversity and inclusion in the community
Xero’s joint Heads of Diversity and Inclusion lead our global diversity and inclusion strategy and initiatives and support our
regions to achieve local diversity priorities. For personal use only use personal For XERO LIMITED 75
Measurable objectives The following is a summary of progress achieved against Xero’s measurable objectives for FY20, as approved by the Board:
Objective Progress Xero maintains a gender balance - At 31 March 2020, Xero’s Board comprised 3 women and 4 men on its Board by having at least 3 female directors and at least 3 male directors Xero attracts diverse talent in the - Progress on gender diversity: At 31 March 2020, 42% of Xero’s employees were female tech industry with particular focus and 42% of Xero’s leadership team were female on women in tech, and maintains: - Included in the 2020 Bloomberg Gender Equality Index globally recognising our commitment to supporting diversity in the workplace - female representation on Xero’s leadership team at or above - Community engagement: Maintained our support for organisations and initiatives to 40% attract and develop a more gender diverse workforce, including Code Like A Girl, GirlbossNZ, Tech Girls Movement, Ladies that UX and Leading Ladies - female representation across all - Engaged in community outreach to increase diversity in the pipeline of talent into tech, employees at or above 40% including promoting careers in tech to girls and women through activities such as (This reflects a 40:40:20 target for coding camps and a one-week Girlcode workshop in Auckland these levels, i.e. 40% women and - Employee networking & development: Supported the launch of a new Women of Xero 40% men, with the remaining 20% (WOX) network group in Australia, hosting regular learning and discussion events in unspecified to allow for flexibility support of gender equality and diversity at Xero and recognise that gender is not binary) - Measurement & monitoring: Maintained an internal diversity dashboard to track key diversity data (including gender diversity data) for internal monitoring and accountability
- Gender pay equity: Conducted our annual organisation-wide pay equity review at Xero and communicated results to employees, and won the ‘On the Journey’ award in the 2019 YWCA Equal Pay Awards (NZ) for our work on pay transparency and gender pay equity
- Communications: Continued to incorporate diversity and inclusion in Xero’s external communications and activities, including through a new page on Xero’s website highlighting Xero’s activities in these areas, and delivered a global International Women’s Day campaign with local events across our offices
- Attraction of talent: Continued to seek diverse talent through recruitment platforms and partners to promote diversity in hiring including Vercida in the UK, Hired in Canada, and Work180 in Australia - Conducted a disability recruitment review in Australia through Australian Network on Disability to identify potential barriers to recruitment for people with disability, with the goal of utilising findings to implement a best practice, barrier-free approach to
recruitment globally For personal use only use personal For 76 CORPORATE GOVERNANCE STATEMENT
Xero is an inclusive work Some of the ways in which we continued to build our inclusive work environment during environment where different the year: contributions and perspectives are - Education to underpin an inclusive environment: Delivered face-to-face training for valued and everyone can bring people managers and online training for employees on Xero’s Respect and their whole self to work Responsibility Policy, and additional training to support diversity and inclusion at Xero, including LGBTQI+ awareness and mental health awareness, and launched a new online learning program on worldviews and religion to build understanding of differences between our people
- “Grassroots” inclusion initiatives: Supported internal groups of diversity and inclusion champions to develop locally meaningful initiatives, such as the creation of the WOX network group in Australia and participation in the Midsumma Festival Pride parade in Melbourne
- LGBTQI+ inclusion: Introduced options in Xero’s internal human resources system for employees to identify as non-binary or gender diverse
- Disability inclusion: Participated in the Australian Network on Disability’s PACE mentoring program in Australia, and achieved Level 2 Disability Confident Employer status in the United Kingdom
- Mental health & wellbeing: Delivered a range of wellbeing activities including mental health training, resilience workshops, mindfulness programs and initiatives to promote physical health and financial wellbeing - Craig Hudson, Xero’s Managing Director New Zealand & Pacific Islands, was awarded the DiversityWorks 2019 ‘Walk the Talk’ award for his leadership to encourage open discussion of mental health and wellbeing by our people and our small business customers - Completed a strategic review of Xero’s wellbeing initiatives with a view to developing a FY21 global strategy to consolidate and enhance our efforts in this area
- Cultural diversity: Promoted cultural diversity through sharing Xero stories of cultural diversity on World Day for Cultural Diversity, delivering Māori language week activities and Māori language courses in New Zealand, participating in the TupuToa internship program in New Zealand, and holding shared cultural lunches in some of our offices
- Indigenous engagement in Australia: Held NAIDOC week activities to support Indigenous awareness among our people, and hosted events in Sydney and Melbourne for Kinaway and IndigiSpace, organisations that support Indigenous business owners and the development of small businesses by Indigenous people
- Flexible work: Continued initiatives to promote flexible working, including flexible working resources for our people, and conducted a XeroNow episode on work-life balance - Delivered internal polls and a survey to track flexible working and satisfaction with flexible working at Xero
- Support for parents: Launched a pilot parental leave coaching program in Australia, and completed a strategic review of current parental leave entitlements across our regions to support the development of a new global parental leave policy in FY21
For personal use only use personal For - Measuring inclusion: Delivered surveys to capture feedback on the extent to which employees feel that Xero is an inclusive workplace
- Capability development: Joined the Diversity Council of Australia XERO LIMITED 77
Gender diversity statistics The proportion of women employed by Xero Limited and its subsidiaries (Xero Group) as at 31 March 2020 is shown below:1
DIRECTORS LEADERSHIP TEAM EMPLOYEES
Male Female Male Female Male Female 57% 43% 58% 42% 57% 42%
Non-binary 0.1%
2020 2020 2020 2020 2019 2019 2019 2019 At 31 March women men total % women men total % Directors 3 4 7 43% 3 4 7 43% Leadership team2 5 7 12 42% 5 5 10 50% Employees 1,292 1,743 3,0473 42% 1,060 1,464 2,531 42%
1 These figures include permanent full-time, permanent part-time, fixed-term, casual employees and interns, and do not include contractors 2 Xero’s leadership team is defined as the CEO and all senior executives who report directly to the CEO. The leadership team increased from 10 to 12 during the year. The number of women on the leadership team remained unchanged 3 Xero has an optional gender identification question that allows employees to choose from the following options: female, male, gender diverse, non-binary, none of the options offered and prefer not to say. At 31 March 2020, 3 employees (0.1%) had selected non-binary and 9 employees (0.3%) had selected none of the options offered or prefer not to say, and are included in the total. 50 employees (1.6%) were excluded from the total because they have not responded to the gender identification question
WGEA report notification Xero’s Australian subsidiary, endorse the directors who will stand for re-election at the Xero Australia Pty Limited, submits an annual Workplace Annual General Meeting (AGM). Gender Equality Report under the Australian Workplace Gender Equality Act 2012 (available once published on Evaluation of the leadership team WGEA’s website at www.wgea.gov.au). The Chair of the Board, with support from the P&R Committee, reviews and makes recommendations on the performance Evaluation of the Board evaluation of the CEO. The CEO, with oversight from the P&R On an annual basis, the Board, with assistance from the Committee, reviews and makes recommendations on the Nominations Committee, reviews and evaluates its performance evaluation of the rest of Xero’s leadership team. performance (including against the requirements of the The performance of Xero’s leadership team is reviewed Board Charter) and the performance of Committees and annually. Performance reviews are conducted by assessing individual directors. each executive’s performance against specific and measurable These performance reviews are conducted both internally and, quantitative and qualitative performance criteria. The on a periodic basis, externally with the assistance of a assessment is then discussed with the P&R Committee. facilitator. The Board conducted an internal performance The performance criteria against which the executives are review during FY20. This review evaluated Board, Committee, assessed are aligned with the financial and non-financial For personal use only use personal For and individual director performance. objectives of Xero.
The Board, with guidance from the Nominations Committee, Performance reviews for Xero’s leadership team took place for determines the size and composition of the Board, and the FY20 in accordance with this process. The remuneration appointment, re-election or retirement of directors. A director outcomes resulting from the performance reviews for the CEO does not participate in the decision regarding their own and Chief Financial Officer (CFO) are detailed in pages 98 to 106 re-election. of this Annual Report in the Remuneration Report.
After considering a number of factors, including the results of the performance reviews, the Board determines whether to 78 CORPORATE GOVERNANCE STATEMENT
PRINCIPLE 2: STRUCTURE THE BOARD TO ADD VALUE
Nominations Committee
Charter The Nominations Committee Charter sets out the Director appointment In selecting and appointing new Nominations Committee’s role to, in summary, assist the Board directors, the Board identifies and considers qualified potential in relation to Board and Committee size, composition, candidates, in light of the appropriate mix of skills, knowledge, performance evaluation, succession planning, and director and experience, diversity, and independence that the Board and CEO appointment. The Nominations Committee Charter is Committees are seeking to achieve, and the time commitment available on Xero’s website. required from non-executive directors. Before appointing a director, Xero undertakes appropriate background checks to The Nominations Committee Charter provides that the determine the candidate’s suitability. Committee will consist of a majority of independent directors, be chaired by an independent non-executive director, and have Suitable candidates are appointed by the Board and hold office at least three members. The Committee composition meets until Xero’s next AGM, where they are then eligible for election. these requirements. The Committee meets at least four times In determining Board membership, the Board seeks to achieve per year and all directors have a standing invitation to attend a mix of skills and diversity that includes experience in the its meetings. areas set out in the table on the following page. The table Details about the Nominations Committee membership and summarises the directors’ relevant skills as at 3 April 2020. meeting attendance are set out in Principle 1 on page 73. The Board is satisfied that the skills matrix demonstrates that Responsibilities The Nominations Committee’s duties and the Board has the appropriate mix of skills and experience responsibilities include: necessary to oversee the governance and operations of Xero.
- Regularly reviewing and making recommendations to the Board as to the size and composition of the Board and its Committees
- Overseeing the search for, and selection of, new directors for nomination for appointment by the Board
- Making recommendations to the Board regarding the appointment of the CEO, as well as the nomination of directors for election or re-election by shareholders
- Overseeing and regularly reviewing an appropriate director induction program, as well as ensuring all directors have access to a professional development program
- Overseeing the regular assessment of, and making recommendations to the Board as to, the independence of each director and associated disclosures
- Developing succession plans for the Board to maintain an appropriate mix of skills, knowledge, experience,
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Board skills matrix
Capability Number of directors with the capability
Cloud Expertise in business software and delivering solutions at scale through cloud platforms within the SaaS industry
Digital product management and marketing Digital product expertise with extensive expertise across technology trends, and implications and the software and technology product value chain
Strategy and development Corporate strategy and development including M&A and strategic partnerships
Go-to-market and customer experience Deep customer insight and advocacy. Go-to-market expertise including direct sales, internet sales and new markets, and specific customer channel experience
Financial expertise Financial expertise with deep public company experience in finance, accounting, planning and investor relations
International markets Exposure to at least two of Xero’s key international markets (Asia, Americas, EMEA, New Zealand and/or Australian markets)
Listed company governance; risk Depth of expertise in listed company governance, compliance and risk management
People and culture Remuneration, workforce planning, talent, culture, and diversity and inclusion
High capability Medium capability
Independence
Xero considers a director to be independent when they are a having regard to the relevant factors listed in the ASX non-executive director who is independent of management Principles and Recommendations, the following directors of and free of any business or other relationship that could Xero are considered to be independent: materially interfere with (or could reasonably be perceived to – David Thodey (Chair) materially interfere with) the independent exercise of their – Mark Cross (commenced 1 April 2020) unfettered judgement, having regard to the best interests of – Lee Hatton Xero as a whole. – Dale Murray In the context of director independence, “materiality” is – Susan Peterson considered from both Xero and an individual director – Graham Smith (resigned as a director effective perspective. 31 March 2020)
The Board makes an assessment of the independence of each The length of service of each director is ascertainable from the
For personal use only use personal For director upon their appointment and annually thereafter. information on pages 13 and 14 of this Annual Report. Directors are required to disclose to the Board relevant personal interests and conflicts of interest on an ongoing basis. In accordance with the definition of independence above, and 80 CORPORATE GOVERNANCE STATEMENT
Board composition and Chair
The Board Charter states that the Board will consist of a Board, facilitate constructive discussion at Board meetings, majority of independent non-executive directors. The Chair of and ensure that the Board functions effectively and Xero, David Thodey, is assessed as an independent non- communicates the Board’s position to shareholders. executive director. The Chair’s role is to, in summary, lead the
Board diversity and tenure
As at 31 March 2020
Tenure Gender Location
0–3 years 3-6 years Male Female US NZ 29% 42% 57% 43% 14% 29%
9+ years UK AU 29% 14% 43%
No directors are within the 6-9 year tenure bracket
Induction
All new Board members are given appropriate induction to member has the opportunity to meet with existing Board enable them to gain an understanding of Xero, its operations members, Xero’s leadership team, and relevant members of the and values, its financial, strategic, and risk management senior management team. All Board members are expected to position, and the rights, duties and responsibilities of the maintain the skills required to discharge their respective roles.
Board, its Committees and management. Each new Board For personal use only use personal For XERO LIMITED 81
PRINCIPLE 3: ACT ETHICALLY AND RESPONSIBLY
Code of Conduct
Xero has a Code of Conduct (the Code), which applies to all the Xero Group (and their employees). The policy also applies directors, officers, employees, contractors and consultants of to the relatives, dependants or spouses of any of those people. the Xero Group. The Code details Xero’s standards and values The policy aims to encourage a culture of openness and and sets out expectations for behaviour and conducting accountability within the Xero Group. It includes topics such as business at Xero. The Code is underpinned by Xero policies, the types of concerns that can be raised, how to raise some of which are global and some of which are country concerns, how whistleblowers will be protected and supported, specific, and include topics covering safety and wellbeing, and how Xero will investigate and deal with any concerns that respect and consideration, and workplace behaviour. The Code are raised. also sets out Xero’s zero-tolerance approach to bribery, The policy is available on Xero’s website and is also made facilitation payments, and corruption in any form. available to employees via Xero’s intranet along with The Code is available on Xero’s website and is also made supporting information specific to relevant regions. available to employees via Xero’s intranet.
Modern Slavery and Human Trafficking Statement Whistleblower Policy Xero has published a statement (under Section 54(1) of the Xero has a Whistleblower Policy, which applies to everyone United Kingdom’s Modern Slavery Act 2015) setting out the who currently works or formerly worked at any entity in actions that it has taken to understand potential modern the Xero Group (including all directors, officers, employees, slavery risks related to its business and supply chains and to contractors, consultants, volunteers, interns, casual workers implement steps to prevent slavery and human trafficking (the and agency workers) and to any current or former supplier of UK Statement). goods or services (whether paid or unpaid) to any entity in The current UK Statement is available on Xero’s website.
PRINCIPLE 4: SAFEGUARD INTEGRITY IN CORPORATE REPORTING
Audit and Risk Management Committee
Purpose The ARM Committee Charter (the ARM Charter) sets Responsibilities The ARM Committee is responsible for out the ARM Committee’s role to, in summary, assist the Board providing recommendations and advice to the Board on in relation to financial reporting principles and policies, areas including: integrity of Xero’s financial statements, audit functions, - Reviewing financial statements and financial forecasts internal control processes, risk management, and legal and intended for external publication and the results of the regulatory compliance. The ARM Charter is available on half-year review and full year audit Xero’s website. - Reviewing Xero’s corporate and financial reporting and The ARM Charter provides that the Committee will consist of disclosure processes, as well as Xero’s accounting policies non-executive directors, be chaired by an independent director and financial reporting practices and have at least three members, a majority of whom are independent. The ARM Charter also provides that all members - Overseeing the effectiveness of the accounting and internal will be financially literate, and at least one member will have control systems accounting or related financial management expertise. The For personal use only use personal For - Appointment, reappointment, removal, and remuneration Committee composition meets these requirements. The or replacement of the external auditor as well as approving Committee meets at least four times per year and all directors and reporting annually on the fees for and terms of the have a standing invitation to attend its meetings. external auditor’s engagement, and on the scope and Details about ARM Committee membership and meeting adequacy of the audit plan of the external auditors attendance are set out in Principle 1 on page 73. - Reviewing and reporting on the overall adequacy and effectiveness of relevant internal controls, processes and compliance 82 CORPORATE GOVERNANCE STATEMENT
- Approving and reviewing the structure of the Assurance replaced by a new senior audit partner from FY21. The policy function, the scope and adequacy of the program of work also requires the external auditor to confirm annually that it and reviewing significant assurance findings and action has complied with all professional regulations relating to taken by management to address these auditor competency and independence.
- Annually assessing and reviewing the overall adequacy and The external auditor will attend and be available to answer effectiveness of Xero’s risk management framework, the shareholder questions at the AGM. methodology and processes for identifying, assessing, monitoring and managing financial and non-financial risks, Declaration regarding financial statements and the risk appetite As a New Zealand domiciled company, section 295A of the Reporting The Chair of the ARM Committee communicates Australian Corporations Act 2001 (Cth) is not applicable to the findings of the Committee to the Board at the next Xero. However, the CEO and CFO provide written statements to Board meeting. the Board in accordance with the ASX Principles and To ensure that the external auditor remains independent Recommendations, in respect of the half and full year reporting at all times, non-audit work is authorised by the ARM periods. These statements confirm whether, in their opinion, Committee. the financial records of Xero have been properly maintained and that the financial statements comply with the accounting Xero is committed to ensuring that the external auditor carries standards and give a true and fair view of the financial position out its function independently and has adopted an Auditor and performance of Xero, and that their view is founded on the Independence Policy. The policy requires that the senior audit basis of a sound system of risk management and internal partner must be rotated at least every five years. The current control which is operating effectively in all material respects. senior audit partner has been serving since FY16 and will be
PRINCIPLE 5: MAKE TIMELY AND BALANCED DISCLOSURE
Continuous Disclosure Policy
Xero’s Continuous Disclosure Policy describes the key Secretary is primarily responsible for overseeing and obligations of the Board and Xero’s leadership team to ensure coordinating all communications with the ASX, and is the that Xero complies with its disclosure obligations under the Disclosure Officer for the purpose of the policy. The Authorised ASX Listing Rules. The Board is responsible for compliance with Spokespersons of Xero include the Chair, the CEO, the CFO, the Xero’s continuous disclosure obligations. The Board has Executive General Manager of Investor Relations, the Executive established a Disclosure Committee, comprising the CEO, an General Manager of Communications, the Director of Corporate independent director, the CFO, and the Chief Legal Officer & Communications, and any other person authorised by the CEO. Company Secretary to support this primary responsibility and The policy is available on Xero’s website.
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PRINCIPLE 6: RESPECT THE RIGHTS OF SECURITY HOLDERS
Shareholder communication Investor relations program
Investor centre Xero's website has a dedicated Investor Xero has an investor relations function which operates a Centre. This provides important information about Xero and its comprehensive and active investor relations program. governance that is relevant to Xero’s shareholders. Xero’s The program supports Xero’s commitment to ensure its Investor Centre includes: shareholders receive important information in a timely and effective manner and facilitates close dialogue with investors. - Xero’s Board and Committee Charters, policies and Activities undertaken as part of the investor relations program Constitution include: - Profiles of Xero’s directors and leadership team - Post-result and ad hoc meetings with institutional investors - ASX releases and analysts
- Media releases - Attendance at a range of domestic, regional and global investor conferences - Half and full year financial results and investor presentations - Pre-AGM engagement with our largest beneficial interest holders and the primary governance advisory bodies - Links to live webcasts or conference calls for the financial results investor briefings - Engagement with the retail investor community through close involvement with shareholder associations - Historical financial reports and share price
- Details of Xero’s share registry provider, Link Market Services Limited Annual General Meeting
- An online form to enable investors to send enquiries Xero actively encourages shareholders to attend our AGM and directly to the Xero investor relations team to ask questions of the Chair, Board, CEO, CFO and other attending members of Xero’s leadership team: Annual Report and other shareholder communications Alongside the publication of half and full year results, Xero’s - Shareholders are notified of the AGM in advance of the Annual Report is made available to shareholders electronically meeting in accordance with regulatory requirements (and by post when elected) and includes relevant information - Shareholder voting is conducted via a poll, and about the operations of Xero and other required disclosures. shareholders may vote electronically or by proxy Each shareholder also receives a Notice of Annual General - For the last four years, Xero has held a hybrid AGM, Meeting, inviting them to attend and participate in Xero’s AGM. meaning shareholders can attend the meeting in person or virtually via an online platform. If shareholders attend virtually, they are able to watch the meeting live, vote, and ask questions online. Xero’s FY20 AGM will be fully virtual via an online platform provided by Xero’s share registrar,
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PRINCIPLE 7: RECOGNISE AND MANAGE RISK
Audit and Risk Management Committee
Purpose As mentioned in Principle 4 on page 81, the and financial risks. The risk dashboard is reviewed with each Board has established an ARM Committee that operates under member of Xero’s leadership team at least twice per year. Risks the ARM Charter, which is available on Xero’s website. lying outside the boundaries of Xero’s agreed risk appetite require proactive mitigation and are included in an ongoing The Board is ultimately responsible for ensuring that material action plan, which is tracked and monitored on a periodic basis risks facing Xero have been identified and that adequate by Xero’s leadership team. controls, monitoring, and reporting mechanisms are in place and operating effectively. The ARM Committee assists The ARM Committee reviews and approves the risk appetite the Board with its oversight of risk management, audit, parameters, and reviews the risk dashboard at least twice per and compliance. year to ensure it has oversight of status and key changes. It also periodically oversees the action plan and, together with The ARM Committee operates in accordance with the ARM the Board, monitors key mitigation actions recorded on the Charter, which sets out its responsibilities for monitoring Xero’s dashboard. The ARM Committee reviewed Xero’s overall risk risk management, including how Xero identifies, assesses, and management framework during FY20 and considered that it is controls strategic, operational, and financial risks within the sound. During FY20 an Executive General Manager of Risk and Board approved risk appetite. This is designed to ensure the Assurance was appointed to oversee and better optimise the adequacy and effectiveness of Xero’s ongoing risk management operation of the risk management framework and drive program, including policies and guidelines relating to corporate further improvements. governance, legal, regulatory and ethical compliance, business continuity management, data privacy, and information systems security. Internal audit
Xero has an internal Assurance function which provides Risk framework independent and objective assurance and advice on Xero’s organisational governance, risk management and internal Xero has an enterprise risk management framework that is control processes. The Assurance function assists the business managed by the CFO and overseen by the ARM Committee. in understanding and managing risk and provides confidence There are several components to Xero’s risk management that the key elements of the business that are relied on to framework including: manage risk are in place and working effectively.
- Policies and procedures covering key financial and To maintain independence, the Executive General Manager non-financial risks of Risk and Assurance has a reporting line to the Chair of the ARM Committee and regularly meets with the Chair - Guidelines and limits for approval of all expenditure, without other management present. The Assurance function including capital expenditure and investments develops an assurance plan which is endorsed by the ARM - Various risk management governance forums to oversee Committee twice per year. The ARM Committee receives and key areas of risk, including the Security Governance Group reviews reports regarding assurance activity undertaken and, through these reports, monitors the progress of management - Due diligence processes for M&A activities action plans. A key component of Xero’s risk management framework is the regular review of key risks and opportunities by the Xero leadership team. A Xero Group risk profile was developed through a series of workshops conducted by the strategy function and involved Xero’s leadership team, senior
For personal use only use personal For management, and operational specialists. They assessed areas of potential risk to the business, estimated likelihoods, impacts, and mitigation strategies. The identified discrete risks are included in a risk dashboard according to the key risk categories, which include operational, strategic, legal, XERO LIMITED 85
Management of economic, environmental, two years. Xero has also produced a Service Organization and social sustainability risks Control 2 (SOC 2) type II report annually for the past four years, Xero operates in an online environment, with its operational which is the result of an independent assessment of controls in model primarily utilising office-based employees. Accordingly, place for security, confidentiality, and availability. Xero’s environmental footprint is relatively small and is Xero hosts its data in Amazon Web Services (AWS) in US made up largely from the energy used in its offices, third-party locations. All locations have the same security measures to data centres, employee travel, and from the typical protect Xero’s and our customers’ information. consumables of an online, office-based business. However, Xero has the following company-wide security practices and we acknowledge that how we conduct our business has an procedures in place: impact on a range of stakeholders, the communities in which we operate, and on the environment more broadly. - Executive General Manager of Security, accountable for More information about our approach to social and information security environmental impact is available on Xero’s website at - Security strategy, which is communicated to the Board by www.xero.com/au/about/social-and-environmental-impact. Xero’s leadership team There are a number of business risks that could materially - An internal security governance group, which meets impact Xero. As part of the risk management process regularly and has Xero leadership team representation described above, Xero has identified and assessed those areas of risk that may impact the business. Effective monitoring - An information security risk management framework and mitigation of these risks supports Xero’s ongoing growth - Formalised security policy and security standards and protects returns. Key areas of risk are described below. Other risks relevant to economic sustainability are noted on - Business continuity management policy and plans pages54 to 58 of this Annual Report in the Notes to the - Security awareness training is conducted at least annually Financial Statements. - Data Classification Standards are regularly communicated Technology platform & information security As Xero to our employees, which incorporate the understanding of continues to grow its customer base and broaden product the sensitivity of data that is dealt with as part of business usage across current users, it must ensure that its platform is activities scalable. This enables Xero to continue to provide the same levels of quality user experience as traffic grows on the Data protection Xero has a global data protection framework platform. We closely monitor all relevant aspects of the and privacy program in place. Xero’s data protection platform to identify areas that may need to be addressed to framework enables management of all personal data collected ensure future performance robustness. in compliance with regulations in regions where Xero operates. Our approach to data protection is built around Xero is committed to the security of its customers’ information four key principles – transparency, enablement, stewardship and has partnered with industry-leading security vendors to and security. leverage their platforms and expertise to protect its systems. Xero has a security team that is responsible for security Strategic direction and implementation A clear and risk management, product and platform security, security disciplined approach to strategic choices and delivery is key to operations, security compliance, and security training success as Xero grows and pursues a wider range of strategic and awareness. objectives in more markets. With Board oversight, Xero’s leadership team reviews the strategic direction on an ongoing Xero takes a risk-based approach to security, which means basis and shares learnings from across the business as well as tighter security controls are implemented where risk to the incorporating the impact of external developments as required. business and our customers is higher. In order to manage Underlying initiatives are reviewed and updated, assigned security risks within Xero’s risk appetite, processes are in place owners, and tracked on a regular basis. for identification, assessment, and treatment of security risks.
For personal use only use personal For Xero maintains a robust security management program, including a comprehensive information security management system which is audited annually by an accredited and independent external auditor. As part of our commitment to information security, Xero has successfully maintained an ISO/IEC 27001 Information Security Certification for the past 86 CORPORATE GOVERNANCE STATEMENT
Innovation momentum and delivery It is critical that Xero and capability development supports Xero’s ongoing delivery maintains its ability to stay ahead of the competition and of product innovation. continues to build and deliver innovative products and services Access to talent As Xero grows, it requires more talent to customers, providing Xero with a competitive advantage. working across the globe. The organisational model needs to Xero proactively aligns its teams with its strategy to more constantly evolve to serve more teams in more diverse rapidly and efficiently advance Xero’s goals. We have processes locations. In addition to current strategies to attract talent into to monitor progress, as well as enabling delivery through current locations, alternative approaches are being explored to improving Xero’s product management capability. This attract talent to new locations. foundation of strategic alignment, tracking, oversight,
PRINCIPLE 8: REMUNERATE FAIRLY AND RESPONSIBLY
People & Remuneration Committee
Charter The P&R Committee Charter (the P&R Charter) sets Responsibilities The P&R Committee’s duties and out the P&R Committee’s role to, in summary, assist the Board responsibilities include: in relation to overseeing the human resources activities of - Overseeing appointment, termination, performance and Xero, including overseeing strategies and policies relating to succession planning of Xero’s leadership team (other than organisational structure and culture, remuneration, employee the CEO) performance and development, and succession planning of Xero’s leadership team (other than the CEO). The P&R Charter - Reviewing and recommending to the Board Xero’s is available on Xero’s website. remuneration strategy, structure and policy, and short and long-term incentive plans, including amendments to such The P&R Charter provides that the Committee will consist of a plans and other material employee benefits majority of independent directors, be chaired by an independent non-executive director, and have at least three - Annually making recommendations to the Board about members. The Committee composition meets these measurable objectives for achieving diversity and assessing requirements. The Committee meets at least four times per the effectiveness of the Diversity and Inclusion Policy, year and all directors have a standing invitation to attend measurable objectives for diversity and the progress its meetings. toward achieving them
Details about P&R Committee membership and meeting More information about our approach to remuneration is set attendance are set out in Principle 1 on page 73. out on pages 94 to 111 of this Annual Report.
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Disclosures
All financial figures in this section of the Annual Report are in New Zealand dollars except where indicated otherwise. References to FY20 are to the financial year ended 31 March 2020. References to FY19 are to the financial year ended 31 March 2019. Xero Group means Xero Limited (Xero) and its subsidiaries.
EQUITY HOLDINGS OF DIRECTORS, CEO & CFO
Number of ordinary Number of unlisted options Number of restricted stock At 31 March 2020 shares (Shares) (Options) units (RSUs) Non-executive directors David Thodey¹ 4,461 – – Rod Drury² 15,719,779 – – Lee Hatton 9,378 – – Dale Murray 950 – – Susan Peterson 2,630 – – Graham Smith – – – Craig Winkler³ 9,275,990 – – CEO & CFO Steve Vamos 10,500 180,000 18,118 Kirsty Godfrey-Billy⁴ 1,884 120,000 1,261
1 Shares are held by Aspiring Co Pty Limited on behalf of the Thodey Family Trust. David Thodey is a director of Aspiring Co Pty Limited and the beneficiaries of the Thodey Family Trust are the immediate family members of David Thodey 2 Shares are held by Rodanna Ventures Trust. The trustees of the Rodanna Ventures Trust are Rodney Kenneth Drury, Anna Margaret Clare Drury, and Scott Moran. The beneficiaries of the Rodanna Ventures Trust are the immediate family members of Rodney Kenneth Drury and Anna Margaret Clare Drury 3 8,254,545 Shares are held by Givia Pty Limited, the trustee of an Australian charitable trust. Craig Winkler is a director of Givia Pty Limited; he and his family members are not beneficiaries of the trust. A further 1,000,000 of Givia’s Shares are the subject of a stock borrow arrangement in connection with Xero's convertible notes issue, as disclosed to the Australian Securities Exchange (ASX) on 26 September 2018. 21,445 Shares are held by a custodian for the benefit of Bangarie Investments Pty Limited. Craig Winkler is a director of Bangarie Investments Pty Limited
4 The 1,261 RSUs will vest (be converted to Shares) in May 2020 For personal use only use personal For 88 DISCLOSURES
ENTRIES RECORDED IN THE INTERESTS REGISTER Xero maintains an interests register in accordance with the Companies Act 1993 (New Zealand).
Directors’ interests
Directors disclosed the following relevant interests, or cessations of interest, during FY20.
Director/Entity Relationship David Thodey Commonwealth Scientific and Industrial Research Organisation (CSIRO) chair and director National COVID-19 Coordination Commission (NCCC)1 deputy chair Ramsay Health Care Limited director Tyro Payments Limited chair and director Vodafone Group Plc director Mark Cross* Chorus Limited director MFL Mutual Fund Limited / Superannuation Investments Limited chair and director Milford Asset Management Limited chair and director Z Energy Limited director Lee Hatton BLD Group Pty Limited ceased to be a director National Australia Bank Limited ceased to be chief executive officer of UBank and executive general manager of direct banking Suncorp Group Limited chief executive officer of banking and wealth division Dale Murray Founders Intelligence Ltd partner Obelisk Legal Support Solutions Limited ceased to be an advisor Sussex Place Ventures Limited ceased to be a director The Cranemere Group Limited director
1 Finite commitment, at the request of the Australian Government, to advise on Australia’s economic and social response to COVID-19
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Share dealings of directors
Directors disclosed the following acquisitions or disposals of relevant interests in Xero Shares during FY20.
Registered holder Date of acquisition/ Consideration Number of disposal per Share Shares acquired/ (AUD) (disposed) David Thodey Aspiring Co Pty Limited1 5 July 2019 $62.96 4,000 Aspiring Co Pty Limited1 11 October 2019 $66.24 138 Aspiring Co Pty Limited1 14 October 2019 $67.67 170 Aspiring Co Pty Limited1 15 October 2019 $68.63 153 Rod Drury Rodanna Ventures Trust2 21 May 2019 $58.00 (2,000,000) Lee Hatton Lee Hatton3 22 May 2019 $56.20 780 Lee Hatton4 13 November 2019 $70.52 746 Susan Peterson Susan Peterson 6 August 2019 $59.00 803 Craig Winkler Givia Pty Limited5 23 May 2019 $59.72 (650,000) Givia Pty Limited5 27 May 2019 $60.00 (100,000) Givia Pty Limited5 11 November 2019 $75.00 (3,000,000) Bill Veghte6 William Lewis Veghte7 22 May 2019 $56.20 2,164 William Lewis Veghte8 19 July 2019 $61.88 915
1 Shares are held by Aspiring Co Pty Limited on behalf of the Thodey Family Trust. David Thodey is a director of Aspiring Co Pty Limited and the beneficiaries of the Thodey Family Trust are the immediate family members of David Thodey 2 Shares are held by Rodanna Ventures Trust. The trustees of the Rodanna Ventures Trust are Rodney Kenneth Drury, Anna Margaret Clare Drury, and Scott Moran. The beneficiaries of the Rodanna Ventures Trust are the immediate family members of Rodney Kenneth Drury and Anna Margaret Clare Drury 3 Shares issued as full payment in lieu of cash remuneration for role as a director of Xero. At the date of issue, Shares issued represented, as a percentage of total issued capital, 0.001% 4 Shares issued as full payment in lieu of cash remuneration for role as a director of Xero. At the date of issue, Shares issued represented, as a percentage of total issued capital, 0.001% 5 Craig Winkler is a director of Givia Pty Limited, the trustee of an Australian charitable trust. Craig Winkler and his family members are not beneficiaries of the trust. See ASX announcement dated 16 May 2017 for information on disposals by Givia Pty Limited 6 Resigned as a director of Xero effective 15 August 2019 7 Shares issued as full payment in lieu of cash remuneration for role as a director of Xero. At the date of issue, Shares issued represented, as a percentage of total issued capital, 0.002% 8 Shares issued as full payment in lieu of cash remuneration for role as a director of Xero. At the date of issue, Shares issued represented, as a percentage of total issued capital, 0.001%
Insurance Deeds of Indemnity
In accordance with the Companies Act 1993 (New Zealand), Xero has provided deeds of indemnity to all directors and For personal use only use personal For Xero has continued to insure its directors and officers (through officers of Xero and its subsidiaries for potential liabilities and renewal of its D&O insurance policy) against potential liability costs they may incur for acts or omissions in their capacity as or costs incurred in any proceeding, except to the extent directors or officers of Xero or its subsidiaries, prohibited by law. to the extent permitted by law. 90 DISCLOSURES
REMUNERATION REPORTING Xero’s remuneration policy and practices are summarised on pages 94 to 111 of this Annual Report.
SHAREHOLDER INFORMATION The shareholder information set out below is current as at 3 April 2020, unless otherwise specified.
Issued capital The total number of issued Shares in Xero at 31 March 2020 was 141,851,409, of which 339,176 Shares were held on a restricted basis in connection with Xero’s share-based compensation plans.
Distribution of shareholding
Range Number of holders % Shares % 1 to 1,000 23,028 88.64 5,229,991 3.69 1,001 to 5,000 2,457 9.46 5,163,082 3.64 5,001 to 10,000 269 1.04 1,930,400 1.36 10,001 to 100,000 196 0.75 5,063,580 3.57 100,001 and over 28 0.11 124,511,568 87.75 Total 25,978 100 141,898,621 100
There were 514 holders of less than a marketable parcel of Shares as at 3 April 2020, based on a market price of AUD $65.66 per Share.
RSUs and Options There were 52 individuals holding a total of Act 2013 (New Zealand) also apply to Xero (including in 2,860,873 Options and 1,746 individuals holding a total of relation to financial reporting, but not including the provisions 317,196 RSUs. RSUs are a conditional contractual right to be relating to substantial shareholdings). issued an equivalent number of Shares in Xero. There is no requirement on Xero’s substantial shareholders to Substantial holdings and limitations on the acquisition of provide substantial product holder notices to Xero. Xero has securities Xero is a New Zealand incorporated and domiciled not received any such notices during FY20. company listed on the ASX. From a regulatory perspective, this Key limitations on the acquisition of Shares in Xero are means that while the ASX Listing Rules apply to Xero, certain imposed by the following New Zealand legislation: Commerce provisions of the Australian Corporations Act 2001 (Cth) do Act 1986, Overseas Investment Act 2005, and Takeovers Act not. Xero is not subject to chapters 6, 6A, 6B, and 6C of the 1993, together with various regulations and codes promulgated Australian Corporations Act 2001 (Cth) dealing with the under such legislation. acquisition of its Shares (including substantial holdings and takeovers). The Companies Act 1993 (New Zealand) applies to
Xero and certain provisions of the Financial Markets Conduct For personal use only use personal For XERO LIMITED 91
Top 20 holders The names of the 20 largest holders of Xero Shares as at 3 April 2020 are listed below.
Shares Name Number % of held issued capital 1. HSBC Custody Nominees (Australia) Limited 32,569,591 22.95 2. J P Morgan Nominees Australia Limited 27,704,696 19.52 3. Rodney Kenneth Drury & Anna Margaret Clare Drury & Scott Moran 15,719,779 11.08 4. Citicorp Nominees Pty Limited 12,939,515 9.12 5. Givia Pty Limited 8,254,545 5.82 6. HSBC Custody Nominees (Australia) Limited - GSCO ECA 7,367,903 5.19 7. National Nominees Limited 4,410,523 3.11 8. BNP Paribas Noms Pty Ltd
Voting rights Xero has a single class of Shares on issue. Where voting at a meeting of shareholders is by voice or a show of hands, every shareholder present in person, or representative, has one vote. On a poll, every shareholder present in person, or by representative, has one vote for each fully paid Share. In practice, Xero ensures that all resolutions at shareholder meetings are decided by a poll rather than a show of hands.
On-market buy-back There is no current on-market buy-back for Xero Shares. For personal use only use personal For 92 DISCLOSURES
COMPANY INFORMATION
Donations The Xero Group made charitable donations totalling $109,158 during FY20. The Xero Group made no donations to political parties during FY20.
Company directors The following persons held office as directors of Xero Limited during FY20.
Directors Directors who ceased to hold office during FY20 David Thodey (Chair) Bill Veghte (resigned effective 15 August 2019) Rod Drury Lee Hatton Dale Murray Susan Peterson Graham Smith Craig Winkler
Company subsidiaries and directors Xero has 14 wholly owned subsidiaries as shown in the table below. The following persons held office as directors of Xero’s subsidiary companies during FY20.
Jurisdiction Subsidiary Directors Directors who ceased to hold office during FY20 Australia Hubdoc Pty Limited Kirsty Godfrey-Billy Trent Innes Chaman Sidhu Xero Australia Pty Kirsty Godfrey-Billy Limited Trent Innes Chaman Sidhu Canada Hubdoc Inc. Will Buckley Keri Gohman (resigned effective 27 August 2019) Andy Burner James McDonald (resigned effective 25 March 2020) Kirsty Godfrey-Billy James Shulman (resigned effective 25 March 2020) Xero Software Will Buckley Keri Gohman (resigned effective 27 August 2019) (Canada) Ltd Andy Burner Kirsty Godfrey-Billy Hong Kong Xero (HK) Kevin Fitzgerald Limited Kirsty Godfrey-Billy Damien Tampling New Zealand Xero Investments Anna Curzon Limited Kirsty Godfrey-Billy Craig Hudson Xero (NZ) Anna Curzon Limited Kirsty Godfrey-Billy Craig Hudson Xero Trustee Limited Kirsty Godfrey-Billy Singapore Xero (Singapore) Kevin Fitzgerald Pte. Ltd Kirsty Godfrey-Billy Damien Tampling
For personal use only use personal For South Africa Xero South Africa Kirsty Godfrey-Billy (Pty) Ltd Colin Timmis Gary Turner XERO LIMITED 93
United Kingdom Cicerone Limited Anna Curzon Kirsty Godfrey-Billy Gary Turner Hubdoc (UK) Damon Anderson Anna Curzon (resigned effective 16 October 2019) Limited Kirsty Godfrey-Billy Edward Berks (resigned effective 1 December 2019) Gary Turner Xero (UK) Damon Anderson Anna Curzon (resigned effective 16 October 2019) Limited Kirsty Godfrey-Billy Edward Berks (resigned effective 1 December 2019) Gary Turner United States Xero, Inc. Kirsty Godfrey-Billy Keri Gohman (resigned effective 27 August 2019)
There were no changes to the interests of directors of Xero’s subsidiaries during FY20.
No employee appointed as a director of Xero’s subsidiary companies receives any remuneration or other benefits from Xero in their role as a director. The remuneration and other benefits of such employees, received as employees, are included in the relevant bandings for employee remuneration disclosed on page 110 of this Annual Report.
Annual General Meeting Xero’s AGM will be held on Thursday, 13 August 2020 and will be fully virtual via an online platform provided by Xero’s share registrar, Link Market Services Limited. Further details in relation to the AGM will be released in a notice
of meeting at the relevant time. For personal use only use personal For 94 REMUNERATION REPORT
Remuneration Report
In this report
Introduction �������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������� 94 Remuneration strategy ������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������� 94 Xero’s performance ������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������� 97 Remuneration outcome overview ������������������������������������������������������������������������������������������������������������������������������������������������������������������������������ 98 Directors and senior executives ��������������������������������������������������������������������������������������������������������������������������������������������������������������������������������� 99 Remuneration governance ���������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������� 100 Key remuneration components for the CEO and CFO ������������������������������������������������������������������������������������������������������������������������������������������ 101 STI outcomes in detail �������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������105 CEO and CFO remuneration ���������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������106 CEO and CFO employment conditions ��������������������������������������������������������������������������������������������������������������������������������������������������������������������107 Non-executive director remuneration ���������������������������������������������������������������������������������������������������������������������������������������������������������������������107 Employee remuneration ���������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������� 110
Introduction We are pleased to present this report, which is intended to In recognition of the global COVID-19 crisis, we are conscious provide greater clarity about the ways we seek to reward and of the challenges and uncertainties that we, along with many recognise the contribution our Xero teams are making to the organisations, face with respect to business performance and success of small businesses and their advisors around the remuneration. We will continue to monitor and review the world. Our approach to reward and recognition is designed appropriateness of our remuneration approach and outcomes to support Xero's purpose and the successful delivery of in this unprecedented environment. our strategy. In the interest of providing greater transparency and insight This report outlines the principles, approach and structure of into our remuneration practices, this report goes beyond what Xero’s remuneration of directors, CEO Steve Vamos, and CFO we are required to disclose as a New Zealand incorporated Kirsty Godfrey-Billy, and how they align with Xero’s purpose, company. We welcome feedback on this report. values, strategy, and financial results. We also provide details Remuneration strategy on how Xero’s performance in the financial year ended 31 March 2020 (FY20) has driven remuneration outcomes for our Our purpose and values CEO and CFO. Xero’s purpose is to make life better for people in small Xero’s FY20 performance included strong top-line growth, business, their advisors and communities around the
a first ever full-year net profit after tax, and a positive free world. Our purpose is underpinned by five values that are For personal use only use personal For cash-flow result. However, the global operating environment fundamental to everything we do. changed dramatically in March as COVID-19 escalated around the world, and some of the steps taken by Xero to support customers resulted in reduced performance against FY20 financial targets.
This is reflected in moderate performance against short-term incentive (STI) targets for the CEO and CFO. XERO LIMITED 95
Human Challenge Team Ownership Beautiful Xeros are authentic, Xeros dream big, Xeros are great Xeros deliver on Xeros create inclusive and really lead and embrace team players our commitments experiences that care change people love Champion Xero’s Do what we say we Kind and assume best Are curious and think purpose and will do Create experiences intent big priorities that inspire and Own our mistakes delight Inclusive, Welcome challenging Work together to do and take positive approachable and conversations and do what’s best for Xero action Do high-quality show empathy it with respect and our customers work Move fast to get the Are willing to be Lead and embrace Appreciate and right things done Go the extra mile vulnerable, share fears, change, seeking new celebrate each other failures and learnings and better ways and success
Our remuneration principles are designed to ensure our execution of Xero’s strategic plan over a multi-year period. remuneration strategy links closely to Xero’s purpose by Each remuneration principle is reflected in our remuneration driving alignment with Xero’s strategy and values. structure as follows:
Xero's remuneration framework is designed to attract and Alignment: A significant proportion of executive retain best-in-class talent through a remuneration remuneration is contingent on share price, ensuring Xero structure that: executives receive rewards that mirror shareholder outcomes
• ensures alignment with business strategy Fairness: Market competitive up-front cash-based • supports sustainable long-term value creation for remuneration is balanced by equity remuneration with shareholders significant potential upside. Value creation for shareholders is • supports appropriate risk management matched by value creation for employees
Remuneration principles Collaboration: Performance conditions are largely company- wide focused, with a less significant individual component. As a global technology company, Xero is dependent on highly Emphasis on delivering against Xero’s strategic objectives via skilled, specialist employees to implement our strategy. Our a significant equity component ensures Xero’s people must ability to attract, retain, reward, and motivate our people is collaborate to drive personal rewards fundamental to our long-term success. Simplicity: There are no complicated long-term performance Our executive remuneration framework has been carefully and measures that require extensive explanation or to which the purposefully developed to enable this by offering: executives do not have a direct line of sight – the structure • Market competitive fixed remuneration simply incentivises long-term value creation. Short-term • Short-term incentives based on challenging individual and measures are aligned with the voices of the shareholder, company-wide targets, with a deferred equity component customer and employee • A long-term, options-based equity plan that is aligned with For personal use only use personal For Flexibility: Xero’s short-term performance measures Xero’s long-term strategy combined with long-term options strike the right balance This framework is designed to conserve cash so we can between ensuring that Xero executives have sufficient prioritise investment in Xero’s growth. The high proportion of flexibility to respond to changing needs and circumstances, equity within the remuneration structure, and the application while always having regard to Xero’s strategy, long-term of options as an equity instrument, continues to attract vision, and long-term value creation highly skilled people. It also aligns executive performance with shareholder interests and rewards the effective 96 REMUNERATION REPORT
Remuneration structure
Xero’s executive remuneration structure is deliberately weighted to have a substantial portion of total remuneration at risk. A large part of this at-risk component consists of option grants, providing leverage and a growth orientation for our executives that is aligned to our overall strategy.
Component Description Link to strategy and performance Fixed annual • Base salary Reviewed annually based on individual remuneration (FAR) • Retirement benefits (superannuation / KiwiSaver or local skills, experience, accountabilities, equivalent) performance, leadership and behaviours Short-term incentive • An at-risk component set as a percentage of base salary Rewards delivery of key strategic and (STI) • Calculated based on achievement against a range of company- financial objectives, in line with the annual wide performance measures (financial and non-financial) and business plan, and rewards outcomes individual objectives aligned to Xero’s goals for growth and • Paid after a one-year performance period (1 April to 31 March, operational discipline aligned with Xero’s financial year). STI comprises 50% cash Organisational measures are approved by and 50% deferred equity in the form of restricted stock units the People and Remuneration Committee (RSUs). Deferred equity vests one year after grant, subject and aligned with the strategic objectives of to continuing employment and confirmation that no award Xero adjustment events have occurred Long-term incentive • An at-risk component in the form of a block options grant plan Rewards delivery against longer-term (LTE) • Participating executives are granted a block of options that strategy and sustained shareholder value vest in equal portions in each of the second, third and fourth creation. Provides alignment between years after grant shareholder and executive outcomes • New hires / promotions may be invited to participate in the block options plan, with a pro rata allocation to reflect their later entry into the plan • Vesting is subject to continuing employment, which provides an additional time-based retention incentive, and confirmation that no award adjustment events have occurred
Malus and clawback
All executive variable remuneration is subject to malus and clawback in certain award adjustment events, including the following:
• where an executive has acted fraudulently or dishonestly or is in material breach of their obligations to Xero; • where Xero becomes aware of a material misstatement or omission in the financial statements of the Xero Group; or • in any other circumstances (for example, relating to the executive’s conduct) where the award would result in an unfair benefit to the executive
Remuneration benchmarking
Executive remuneration is benchmarked to a specific S&P/ASX100 peer group that is determined to be similar to Xero in terms of operations. Each year, the peer group is reviewed and updated. Xero’s People and Remuneration Committee (P&R Committee), in partnership with an external consultant, conducts a comparative analysis of the executive team’s compensation against reported
roles within that identified peer group. For personal use only use personal For XERO LIMITED 97
Xero’s performance Xero’s financial results over the last five years are shown below:
Measure FY16 FY17 FY18* FY19 FY20 Subscribers 717,000 1,035,000 1,386,000 1,818,000 2,285,000 Annualised Monthly $257,925,000 $359,669,000 $484,421,000 $638,179,000 $820,557,000 Recurring Revenue Operating Revenue* $207,060,000 $295,389,000 $406,659,000 $552,819,000 $718,231,000 Free Cash Flow* ($88,590,000) ($70,831,000) ($28,513,000) $6,451,000 $27,105,000
*Operating Revenue and Free Cash Flow for FY18 has been restated for changes in NZ IFRS 9, NZ IFRS 15, and NZ IFRS 16. FY16 and FY17 have not been restated
Xero’s share price, total shareholder return, and the ASX100 index return over the last five years are shown below:
Measure FY16 FY17 FY18 FY19 FY20 Xero Share Price (AU$)* 13.95 18.10 33.44 48.65 67.91 Xero Total Shareholder -40.18% 29.75% 84.75% 45.48% 39.59% Return ASX100 Total -8.95% 22.78% 3.08% 14.16% -12.60% Shareholder Return
* Closing price for the last trading day in the financial year For personal use only use personal For 98 REMUNERATION REPORT
Remuneration outcomes overview • Value of the CFO’s options that vested during the year Headline remuneration outcomes for Xero’s CEO and CFO are ended 31 March 2020. 20,000 options from a legacy grant in disclosed in the graph below on a realisable basis for FY20, 2016 vested for the CFO this year including: Further details on the CEO's and CFO's STI outcomes are • Fixed annual remuneration presented on page 105.
• Realisable cash and deferred RSU STI awarded based on Further details on the CEO's and CFO's other remuneration FY20 performance, with deferred RSUs yet to be granted elements and outcomes for the year are included in on and vest pending service. 81.8 percent of target STI (56.4 page 102. percent of maximum) was awarded to each of the CEO and CFO. 50 percent is paid in cash and 50 percent deferred into RSUs to vest one year post grant
• Value of the CEO’s one-off performance-based RSUs that vested during the year ended 31 March 2020. 110% of target RSUs were awarded (55 percent of maximum), with one- third vesting this year
• Value of the CFO’s one-off service-based RSUs and shares that vested during the year ended 31 March 2020. All of the RSUs and shares vested
CEO
CFO
0 500,000 1,000,000 1,500,000 2,000,000
Fixed STI cash STI equity RSUs Shares LTE options For personal use only use personal For XERO LIMITED 99
Directors and senior executives This report focuses on the remuneration of Xero’s directors, CEO and CFO in FY20 as identified in the table below.
Country of Position Period position was held during the year residence Executive Steve Vamos New Zealand CEO Full year Kirsty Godfrey-Billy New Zealand CFO Full year Non-executive directors David Thodey Australia Independent non-executive Chair Appointed as director 27 June 2019. Appointed Board Chair effective 1 February 2020 Rod Drury New Zealand Founder, non-executive director Full year Lee Hatton Australia Independent non-executive director Full year Dale Murray, CBE United Independent non-executive director Full year Kingdom Susan Peterson New Zealand Independent non-executive director Full year Craig Winkler Australia Non-executive director Full year Former Bill Veghte United States Independent non-executive director Ceased as director effective 15 August 2019
Graham Smith United States Independent non-executive Chair Ceased as director effective 31 March 2020 For personal use only use personal For 100 REMUNERATION REPORT
Remuneration governance Other members of the Board, the CEO and members of Xero’s Xero’s remuneration governance framework is managed leadership team may be invited to attend meetings of the P&R by the P&R Committee on behalf of the Board. The P&R Committee where appropriate. Committee is tasked with ensuring that Xero’s remuneration The P&R Committee considers all proposals to award variable practices are aligned with Xero’s strategic objectives and remuneration to executives, including recommended cash STI consistent with Xero’s remuneration principles and risk payments and awards of deferred equity, awards of LTE, and appetite. The P&R Committee has regard to the interplay any upcoming vests to determine whether there is an award between remuneration structures and risk when adjustment event (see malus and clawback section on designing structures and setting and determining page 96). remuneration outcomes. External and independent advice Role of the People and Remuneration Committee During the year, the P&R Committee engaged the services The P&R Committee operates under a charter, which is of independent external consultants to provide guidance on available on Xero’s website at www.xero.com/about/investors/ Xero’s remuneration framework to ensure it remains fit for governance. The P&R Committee oversees Xero’s strategies purpose given Xero’s current and expected growth trajectory. and policies relating to: The engagement of independent external consultants • Organisational structure and culture ensured the P&R Committee did not receive advice solely • Remuneration from management or advisors who also received significant • Employee performance and development fees from additional work commissioned by management. • Succession planning for direct reports to the CEO (succession planning for the CEO is managed by the No protection arrangements Nomination Committee) Xero’s Securities Trading Policy prohibits employees and The P&R Committee provides strategic, structural and policy directors from entering into transactions that are intended oversight of remuneration, employee performance and culture to hedge or otherwise limit the economic risk of unvested or for the general Xero workforce, making recommendations restricted Xero securities. to the Board regarding HR policies, remuneration budgets, A copy of Xero’s Securities Trading Policy is available on employee incentive plans, and material employee benefits. Xero’s website at www.xero.com/about/investors/governance The P&R Committee’s oversight of the remuneration of the CEO and direct reports involves closer scrutiny of remuneration quantum and performance outcomes, including developing independent recommendations for CEO remuneration increases and performance outcomes to be presented to the Board.
The P&R Committee seeks input from management where appropriate and also engages the services of independent advisors from time to time to inform decisions.
People and Remuneration Committee independence
Consistent with the ASX Corporate Governance Principles and Guidelines, the P&R Committee consists of three members, the majority of whom are independent, including the Chair. The current membership comprises:
• Susan Peterson (Chair)
For personal use only use personal For • David Thodey • Craig Winkler XERO LIMITED 101
Key remuneration components for the CEO and CFO Further detail is outlined below on how the remuneration structure described on page 96 applies to the CEO and CFO.
CEO remuneration mix
The CEO’s remuneration mix is as follows.
Target Maximum Fixed annual remuneration 30% 44% 26% 38% STI cash
STI equity
LTE
13% 13% 18% 18%
CFO remuneration mix
The CFO’s remuneration mix is as follows.
Target Maximum Fixed annual remuneration 31% 50% 27.5% 44.5% STI cash
STI equity
LTE
9.5% 9.5% 14% 14% For personal use only use personal For 102 REMUNERATION REPORT
Fixed annual remuneration (FAR)
Fixed annual remuneration is set in the context of Xero’s wider, growth-orientated remuneration strategy and considers an individual executive’s skills, experience, accountabilities, performance, leadership and behaviours.
For the CEO, the FY20 remuneration review process resulted in his base salary increasing to $1,145,000 from 1 April 2019. There was also a change in payment currency from Australian currency to New Zealand dollars.
For the CFO, the FY20 remuneration review process resulted in her base salary increasing to $550,000 from 1 April 2019.
Element Details Components Base salary
Retirement benefits (superannuation, KiwiSaver or local equivalent) Process Set and reviewed annually based on individual skills, experience, accountabilities, performance, appropriate benchmarks, leadership and behaviours At risk – short-term incentive (STI)
STI is an at-risk component of remuneration that is structured to reward progress towards and alignment with Xero’s strategic and financial objectives together with creation of value for customers, employees and shareholders in the financial period. STI incentive payments are set as a percentage of base salary, based on level of responsibility and country of residence.
STI is calculated based on achievement against a range of organisational performance measures (financial and non-financial) and individual objectives. STI payments comprise 50% cash and 50% deferred equity in the form of restricted stock units (RSUs).
Element Details Purpose Focus participants on delivery of business objectives over a one-year period Target opportunity (% base salary) CEO 60%, CFO 40% Maximum opportunity (% base salary) CEO 87%, CFO 58% Performance period Performance is measured from 1 April to 31 March Performance measures Performance metrics measure success in relation to our key stakeholders, reflecting the voice of employee, customer and shareholder Financial objectives (60%) Financial objectives reflect the “voice of shareholder” - cash flow and net new monthly recurring revenues (MRR) targets Non-financial objectives (40%) Non-financial metrics are based on: • Voice of Customer – Partner and small business net promoter score (NPS) targets • Voice of employee – Employee NPS and engagement targets • Individual objectives – Goals aligned to company strategic objectives Pay vehicle 50% of STI awarded is paid in cash with the remaining 50% issued in RSUs Vesting conditions RSUs vest one year from grant date, subject to continued service for both executives
The STI performance metrics have been chosen as they focus the CEO and CFO on growing the global subscriber base and creating valued customer experiences while at the same time maintaining operational discipline.
The targets set at the beginning of each financial year are reviewed and approved by the P&R Committee and are aligned to our
longer-term strategic objectives. For personal use only use personal For Performance against financial and non-financial objectives is determined at the end of the financial period after review of executive performance by the CEO, in consultation with the P&R Committee (and in the case of the CEO, by the Board).
At all times the Board retains discretion over any variable payments made and such payments are supported by the P&R Committee which applies a qualitative overview of outcomes to ensure an appropriate balance is always maintained. This ensures there is not undue emphasis on short-term results at the expense of our longer-term vision.
The CEO, Chief People Officer and P&R Committee review and approve all upcoming incentive payments and equity vests to ensure there is not any reason for withholding. XERO LIMITED 103
At risk – long-term incentive (LTE)
LTE is an at-risk component of executive remuneration that is structured to reward the effective execution of Xero’s strategic plan over a multi-year period.
Element Details Purpose Rewards delivery against longer-term strategy and sustained shareholder value creation. Provides alignment between shareholder and executive outcomes and time-based retention through multi-year vesting Maximum opportunity (% base salary) CEO 72%, CFO 64% Pay vehicle Options with an exercise price based on the 20-day VWAP leading up to grant date. Options lapse five years from grant date Grant date Options were granted to the CEO in August 2018 and CFO in June and October 2018 Vesting conditions For the CEO, options vest in two equal tranches in each of the third and fourth years after grant. For the CFO, options vest in three equal tranches in each of the second, third and fourth years after grant. Vesting is contingent upon continued service for both executives
The CEO was invited to participate in the LTE plan from August 2018. As an offset to his existing RSU grants outlined on page 104 below, the total number of options granted to the CEO under the LTE was reduced by 25 percent and vesting in June 2020
was foregone. For personal use only use personal For 104 REMUNERATION REPORT
Legacy CEO and CFO equity arrangements
Details of other equity grants made to the CEO and CFO before the current LTE was adopted are outlined below.
Legacy CEO equity arrangements
Element Details Purpose Focus participant on delivery of business objectives over a one-year period and provide time-based retention through multi-year vesting Target opportunity (% base salary) 70% Maximum opportunity (% base salary) 140% Performance period Performance was measured from 1 April 2018 to 31 March 2019 Performance measures The performance metrics were as follows: Revenue growth 40 percent MRR 40 percent EBITDA 20 percent Pay vehicle RSUs Grant details A total of 32,658 RSUs were issued in April and June 2018 to account for maximum performance. Following confirmation of achievement against targets, 12,276 RSUs were forfeited, leaving 20,382 RSUs to vest. Vesting conditions Shares vest in three equal tranches in May 2019, 2020 and 2021. Vesting is contingent upon continued service Outcome The first tranche of 6,794 RSUs vested in May 2019. The second and third tranches of 6,794 and 6,794 RSUs will vest in May 2020 and May 2021
Legacy CFO equity arrangements
Legacy CFO Options
Element Details Purpose Executive team retention plan intended to reward delivery against longer- term strategy and sustained shareholder value creation. Provides alignment between shareholder and executive outcomes and time-based retention through multi-year vesting Pay vehicle Options with an exercise price based on the 20-day VWAP leading up to grant date. Options lapse five years from grant date Grant details 80,000 options were granted in June 2016 Vesting conditions Options vest in four equal tranches at each 12-month anniversary of the grant date. Vesting is contingent upon continued service Outcome Tranches of 20,000 options vested in June 2017, 2018 and 2019. The final tranche of 20,000 options will vest in June 2020
Legacy CFO RSUs
Element Details Purpose Retention of executives during CEO transition Pay vehicle RSUs
For personal use only use personal For Grant details 3,051 RSUs were granted in April 2018 Vesting conditions Vesting is contingent upon continued service Outcome All RSUs vested in May 2019 XERO LIMITED 105
Legacy CFO shares
Element Details Purpose Company-wide long-term incentive plan incorporating time-based retention through multi-year vesting Pay vehicle Restricted shares Grant details 1,359 shares were granted in July 2017 Vesting conditions Vesting is contingent upon continued service Outcome All shares vested in March 2020
STI outcomes in detail The annual outcomes achieved for CEO and CFO are based on Xero’s FY20 performance as follows:
Objectives Weighting Outcome
Outcome Outcome Threshold Target Maximum (% of target) (% of max)
Company Objectives
Voice of the shareholder¹ 60% 78.0% 44.6%
Voice of the customer 10% 50.0% 50.0%
Voice of the employee 10% 100.0% 100.0%
Total Company Objectives 61.8% 49.4%
Individual Objectives
CEO individual targets 20% 100.0% 100.0%
CFO individual targets 20% 100.0% 100.0%
Total CEO Outcome 81.8% 56.4%
Total CFO Outcome 81.8% 56.4%
1 For the voice of the shareholder component, there is the ability to out-perform up to 200% on the net new MRR measure For personal use only use personal For 106 REMUNERATION REPORT
CEO and CFO remuneration The following table provides details of the actual remuneration received by the CEO and CFO, in the years ended 31 March 2020 and 31 March 2019.
Fixed remuneration Variable remuneration1 Accounting value of grants vested Additional during the year, in the form of: value of all grants vested Total in the year, remuneration Salary Superannuation/ Other² Cash STI Option/ RSU attributable to received ($000s) KiwiSaver ($000s) ($000s) Share grants share price inclusive of ($000s) grants ($000s) appreciation share price ($000s) ($000s) appreciation ($000s) S Vamos 1,145 54 793 270 - 246 167 1,960 2020 S Vamos4 1,0135 54 - -6 - - - 1,067 2019 K Godfrey- 550 14 2 75 184 110 940 1,875 Billy 2020 K Godfrey- 4177 11 2 48 212 - 506 1,196 Billy 2019
1 Includes the value of options, RSUs and shares granted in prior years that vested in the year 2 Other fixed pay relating to annual leave 3 Relates to payout of annual leave under New Zealand requirements, which includes STI received in calculation of payments 4 Amounts shown for S Vamos in FY19 were paid in AUD and are shown in NZD (translated at the average exchange rate for the year) 5 Base salary increased to AU$1,012,500 effective 1 October 2018 6 No STI or LTI amounts were paid to S Vamos during FY19 as his employment with Xero commenced on 1 April 2018 7 Base salary increased to $450,000 effective 1 October 2018 following promotion to the role of CFO
The following tables present current at-risk equity and holdings for the CEO and CFO.
At-risk equity as at 31 March 2020
Opening Granted Vested Exercised Lapsed/ Closing balance1 during the Forfeited balance year Options CEO 180,000 - - - - 180,000 CFO 160,000 - 20,000 40,000 - 120,000 RSUs CEO 20,383 4,530 6,794 N/A - 18,118 CFO 3,051 1,261 3,051 N/A - 1,261 For personal use only use personal For Restricted Shares CFO 1,359 - 1,359 N/A - -
1 The opening balances in this table disclose all vested and unvested options, unvested RSUs and unvested Restricted Shares at 1 April 2019 Equity holdings as at 31 March 2020
Shares Options RSUs CEO 10,500 180,000 18,118 CFO 1,884 120,000 1,261 XERO LIMITED 107
CEO and CFO employment conditions Item Details Basis of contract Ongoing (no fixed term) Notice period CEO – 6 months by either party
CFO – 3 months by either party
Shorter notice may apply by agreement
Non-executive director remuneration The total remuneration available to non-executive directors is fixed by shareholders.
Currently, the annual total aggregate non-executive directors’ remuneration is capped at $2.2 million, as approved by shareholders at Xero’s Annual Meeting in August 2019.
The Board sets the fees for the non-executive directors at a level that provides Xero with the ability to attract and retain directors of a high calibre. Directors have the option to receive their fees in cash or Xero shares.
The fees paid to non-executive directors are structured to reflect time commitment, responsibilities, and workloads. Target fees for non-executive directors are benchmarked to the Australian and New Zealand markets, except where benchmarked non- executive director fees are higher in another market, in which case local benchmarks are used for that market. This reflects the global composition of Xero’s Board.
To preserve independence and impartiality, non-executive directors have not received any performance-related or “at risk” compensation (such as options) since 2016. Xero does not provide any scheme for retirement benefits, other than statutory superannuation, for non-executive directors.
Below are the annual fees payable to non-executive directors during FY20. Directors’ fees are paid in New Zealand dollars in order to avoid exchange rate fluctuations impacting the annual fee cap. Fees are reviewed every two years and were last reviewed early in 2019.
Country of Chair Director Audit & Risk Management People & Remuneration residence ($000s) ($000s) Committee Chair Committee Chair¹ ($000s) ($000s) New Zealand 358 145 30 30 Australia 358 145 30 30 United States 358 252 30 30 United Kingdom 373 145 30 30
1 No additional fees are currently paid for Chair of the Nominations Committee or for membership of any committee For personal use only use personal For 108 REMUNERATION REPORT
The total remuneration1 of, and the value of other benefits received by, each non-executive director during FY20 was:
Director Country of Role Committee 2020 2020 2020 2020 2020 residence Chair base Committee Vested One-off Total fees fees Chair fees Equity Payment ($000s) ($000s) ($000s) ($000s) ($000s) David Australia Chair Nominations 143 - - - 143 Thodey² Committee Rod Drury New NED - 138 - - - 138 Zealand Lee Hatton Australia Independent ARM 138 29 - - 167 NED Committee Dale Murray United Independent - 138 - - - 138 CBE Kingdom NED Susan New Independent P&R Committee 138 22 - - 160 Peterson Zealand NED Craig Australia NED - 138 - - - 138 Winkler Former Director Bill Veghte3 United Independent - 45 4 - - 49 States NED Graham United Former Chair Nominations 399 - - - 399 Smith⁴ States Committee Total 1,277 55 - - 1,3321
1 Total remuneration is presented based on accounting expense and may include amounts earned but not yet received 2 Appointed director 27 June 2019, appointed Board Chair effective 1 February 2020 3 Ceased as a director effective 15 August 2019
4 Ceased as a director effective 31 March 2020 For personal use only use personal For XERO LIMITED 109
Lee Hatton was issued 1,526 Shares in lieu of receiving her director fees in cash during FY20 and Bill Veghte was issued 3,079 Shares in lieu of receiving his director fees in cash during FY20 (for further details, please see the explanatory notes of the 2018 and 2019 notices of meeting). In total, this represented 0.003% of Xero’s issued capital as at 31 March 2020.
The total remuneration1 of, and the value of other benefits received by, each non-executive director during the year ended 31 March 2019 (FY19) was:
Director Country of Role Committee 2019 2019 2019 2019 2019 residence Chair base Committee Vested one-off Total fees Chair fees Equity payment2 fees ($000s) ($000s) ($000s) ($000s) ($000s) Graham Smith United Chair Nominations 310 - - 150 460 States Committee Rod Drury³ New NED - 90 - - - 90 Zealand Lee Hatton Australia Independent ARM 90 20 - - 110 NED Committee Dale Murray United Independent - 111 - - - 111 CBE⁴ Kingdom NED Susan New Independent - 90 - - - 90 Peterson Zealand NED Bill Veghte⁵ United Independent P&R Committee 226 14 59 - 299 States NED Craig Winkler Australia NED - 90 - - - 90 Total 1,007 34 59 150 1,250¹
1 Total remuneration is presented based on accounting expense and may include amounts earned but not yet received 2 For additional Board duties related to M&A and US$300m capital raising in FY19 3 Appointed as a non-executive director effective 1 April 2018. Rod Drury was an executive director during the year ended 31 March 2018 and received executive remuneration from Xero. During that year, he did not participate in Xero’s share-based compensation plans or receive additional remuneration in his capacity as a director 4 Appointed as a director effective 13 April 2018 5 The fees for Bill Veghte differ from the standard annual fees because they include the value of options granted to him in prior periods (2015 and 2016) that vested in the
current year For personal use only use personal For 110 REMUNERATION REPORT
Employee remuneration The following table shows the number of current and former employees of the Xero Group whose remuneration and benefits for FY20 were within the specified bands above $100,000.
Remuneration including share- Number of employees Remuneration including Number of employees based remuneration share-based remuneration 100,000 to 109,999 176 460,000 to 469,999 3 110,000 to 119,999 171 470,000 to 479,999 1 120,000 to 129,999 164 480,000 to 489,999 1 130,000 to 139,999 145 500,000 to 509,999 1 140,000 to 149,999 140 530,000 to 539,999 2 150,000 to 159,999 121 550,000 to 559,999 2 160,000 to 169,999 88 580,000 to 589,999 3 170,000 to 179,999 105 590,000 to 599,999 1 180,000 to 189,999 72 610,000 to 619,999 1 190,000 to 199,999 75 640,000 to 649,999 1 200,000 to 209,999 50 750,000 to 759,999 1 210,000 to 219,999 41 760,000 to 769,999 1 220,000 to 229,999 34 820,000 to 829,999 1 230,000 to 239,999 22 850,000 to 859,999 1 240,000 to 249,999 28 860,000 to 869,999 1 250,000 to 259,999 14 870,000 to 879,999 1 260,000 to 269,999 18 890,000 to 899,999 2 270,000 to 279,999 8 910,000 to 919,999 1 280,000 to 289,999 15 960,000 to 969,999 1 290,000 to 299,999 7 980,000 to 989,999 1 300,000 to 309,999 9 1,000,000 to 1,009,999 1 310,000 to 319,999 15 1,020,000 to 1,029,999 1 320,000 to 329,999 8 1,050,000 to 1,059,999 1 330,000 to 339,999 6 1,250,000 to 1,259,999 2 340,000 to 349,999 7 1,420,000 to 1,429,999 1 350,000 to 359,999 5 1,470,000 to 1,479,999 1 360,000 to 369,999 1 1,650,000 to 1,659,999 1 370,000 to 379,999 4 1,720,000 to 1,729,999 1 380,000 to 389,999 2 1,760,000 to 1,769,999 1 390,000 to 399,999 7 1,870,000 to 1,879,999 1 400,000 to 409,999 3 1,880,000 to 1,889,999 1 410,000 to 419,999 1 1,960,000 to 1,969,999 2 420,000 to 429,999 2 2,060,000 to 2,069,999 1 430,000 to 439,999 2 2,810,000 to 2,819,999 1
For personal use only use personal For 450,000 to 459,999 2
The remuneration covered in the table includes monetary payments received and share-based payments vested (i.e. restricted shares, restricted stock units, and vested options). The table above includes the total remuneration received by the CEO and CFO. XERO LIMITED 111
The value of options vested during the year has been calculated as the difference between the exercise price of those options and the share price on the day the options vest (become exercisable). This methodology is different from that used for this disclosure in Xero's FY19 annual report where the value attributed to vested options was calculated based on the fair value at grant date as determined using the Black-Scholes valuation model. Our revised methodology has been chosen as it provides a closer representation of the actual remuneration received by employees during the year and is consistent with the approach made
within the CEO and CFO remuneration disclosures detailed above. For personal use only use personal For 112
Corporate Directory
Registered offices Directors Leadership team
New Zealand David Thodey, AO (Chair) Steve Vamos Company numbers 19-23 Taranaki Street Mark Cross Chief Executive Officer 183 0488 (New Zealand) Te Aro, Wellington 6011 Rod Drury ARBN 160 661 183 (Australia) Anna Curzon New Zealand Lee Hatton Chief Product Officer Web address Telephone: +64 4 819 4800 Dale Murray, CBE www.xero.com Susan Peterson Kirsty Godfrey-Billy Australia Craig Winkler Chief Financial Officer Auditor 1/6 Elizabeth Street Ernst & Young Hawthorn, Vic 3122 Craig Hudson Australia Managing Director, Stock exchange Telephone: +61 3 9981 0408 New Zealand & Xero’s ordinary shares Pacific Islands are listed on the ASX
Trent Innes Share registrar Managing Director, Link Market Services Limited Australia & Asia Level 13, Tower 4, 727 Collins Street Rachael Powell Melbourne, Vic 3000 Chief Customer Officer Australia Mark Rees Telephone: +61 1300 554 474 Chief Technology Officer
Nicole Reid Chief People Officer
Chaman Sidhu Chief Legal Officer & Company Secretary
Damien Tampling Chief Strategy & Corporate Development Officer
Gary Turner Managing Director, United Kingdom & EMEA
Tony Ward
President, Americas For personal use only use personal For